TAX COURT RULES ON BALLARD, KANTER, LISLE CASES.

Karen L. Hawkins, for petitioner Naomi R. Kanter in docket Nos. 712-86, 1350-87, 31301-87, 33557-87, 3456-88, 32103-88, and 26251-90.

Steven S. Brown and Royal B. Martin, for petitioners Claude M. and Mary Ballard in docket Nos. 16421-90, 20211-91, 21616-91, 1984-92, 23743-92, and 22884-93, and for petitioners Estate of Robert W. Lisle, Deceased, Thomas W. Lisle and Amy L. Albrecht, Independent Co-Executors, and Estate of Donna M. Lisle, Deceased, Thomas W. Lisle and Amy L. Albrecht, Independent Co- Executors, in docket Nos. 21555-91, 16164-92, and 7557-93.

John J. Comeau, Frederic J. Fernandez, James M. Klein, and Mark J. Miller, for respondent.

                               CONTENTS

I. Procedural History

These cases, along with a number of cases instituted by another taxpayer, Investment Research Associates, Ltd., originally were consolidated for trial, briefing, and opinion. Special Trial Judge D. Irvin Couvillion tried the cases but was statutorily prohibited from entering the decisions. See sec. 7443A(c).³ Special Trial Judge Couvillion prepared an initial report that included his recommended findings of fact and opinion (the STJ report). The cases were then assigned to Judge Howard A. Dawson, Jr., for adoption of the STJ report and entry of decisions. Under Rule 183 as in effect at the time, the STJ report was not filed or otherwise entered into the record of the cases.⁴ Special Trial Judge Couvillion subsequently collaborated with Judge Dawson in preparing a final report, Inv. Research Associates, Ltd. v. Commissioner, T.C. Memo. 1999-407, in which the Court sustained, inter alia, respondent's determinations that petitioners Burton W. Kanter (Kanter),⁵ Claude M. Ballard (Ballard), and Robert W. Lisle (Lisle)⁶ (collectively petitioners) failed to report income from a kickback scheme and were liable for additions to tax for fraud. The Court also sustained a number of adjustments respondent determined with regard to Kanter that were unrelated to the alleged kickback scheme.

Following entry of decisions, Kanter, Ballard, and Lisle appealed their cases to separate Courts of Appeals.⁷ In Ballard v. Commissioner, 321 F.3d 1037 (11th Cir. 2003), and Estate of Kanter v. Commissioner, 337 F.3d 833 (7th Cir. 2003), the Courts of Appeals for the Eleventh and Seventh Circuits, respectively, affirmed this Court's holdings that (1) Ballard and Kanter failed to report income from the alleged kickback scheme, and (2) each was liable for additions to tax for fraud.⁸ The Courts of Appeals also affirmed this Court's earlier ruling that it was not obliged to make the STJ report part of the record. In Estate of Lisle v. Commissioner, 341 F.3d 364 (5th Cir. 2003), the Court of Appeals for the Fifth Circuit affirmed this Court's holding that the Estate of Lisle was liable for tax deficiencies related to the alleged kickback scheme for the years 1987 to 1989 but reversed this Court's holding that the Estate of Lisle was liable for additions to tax for fraud.

Ballard and Kanter filed petitions for certiorari with the Supreme Court. The Estate of Lisle did not file a petition for certiorari.

In Ballard v. Commissioner, 544 U.S. 40 (2005), the Supreme Court concluded (1) the collaborative process this Court employed in the review of the STJ report and adoption of the Court's Memorandum Opinion in Inv. Research Associates, Ltd. v. Commissioner, supra, was not warranted by or described in the Court's Rules of Practice and Procedure, and (2) the STJ report was required to be included in the record to permit fully informed appellate review regarding the question whether the Special Trial Judge's "credibility and other findings made in that report were accorded '[d]ue regard' and were 'presumed . . . correct'". Ballard v. Commissioner, supra at 60. Thus, the Supreme Court reversed the judgments of the Courts of Appeals for the Seventh and Eleventh Circuits and remanded the cases for further proceedings consistent with its opinion.

In Estate of Kanter v. Commissioner, 406 F.3d 933, 934 (7th Cir. 2005), the Court of Appeals for the Seventh Circuit remanded the Kanter cases to this Court "for further proceedings consistent with the Supreme Court's decision in Estate of Burton W. Kanter v. Commissioner of Internal Revenue, No. 03-1034."

In Ballard v. Commissioner, 429 F.3d 1026, 1027 (11th Cir. 2005), the Court of Appeals for the Eleventh Circuit remanded the Ballard cases to this Court with the following instructions:

In Estate of Lisle v. Commissioner, 431 F.3d 439 (5th Cir. 2005), the Court of Appeals for the Fifth Circuit recalled its earlier mandate and directed this Court to reexamine the question whether the Estate of Lisle is liable for tax deficiencies consistent with the instructions handed down by the Court of Appeals for the Eleventh Circuit in Ballard v. Commissioner, 429 F.3d at 1027.⁹

Following the remands, these cases were assigned to Judge Harry A. Haines, a Judge who was not involved in the prior proceedings in these cases.¹⁰

II. Amendment to Rule 183

In response to the Supreme Court's holding in Ballard v. Commissioner, 544 U.S. 40 (2005), the Court amended Rule 183 to provide a procedure for service on the parties of a Special Trial Judge's recommended findings of fact and conclusions of law and the filing of objections and responses. The pertinent portions of new Rule 183 state as follows:

III. Notices of Deficiency

Respondent issued notices of deficiency to petitioners as summarized below:

Burton W. and Naomi R. Kanter

                                Additions to Tax              Penalty

                            Additions to Tax          Penalty

In amended pleadings, respondent asserted increases in the deficiencies in tax and additions to tax for the taxpayers and years as follows: Burton W. and Naomi R. Kanter for the taxable years 1978 to 1984 and 1986 to 1989; Claude M. and Mary B. Ballard for the taxable years 1975 to 1982, 1984, and 1987 to 1989; and Estates of Robert W. Lisle, Deceased, and Donna M. Lisle, Deceased, for the taxable years 1984 and 1987 to 1989. In the amended pleadings referred to above, respondent asserted that (1) the underpayments of tax with respect to all or substantial portions of the increased deficiencies in tax are subject to the addition to tax for fraud pursuant to section 6653(b);¹³ and (2) in the alternative, if the Court holds that petitioners are not liable for additions to tax for fraud, then petitioners are liable for additions to tax under sections 6653(a)(1) and (2) and 6659(a) and increased interest under section 6621(c), or if the underpayment was for 1989, subject to a penalty under section 6662.¹⁴

In the amended pleadings referred to above, respondent did not calculate or assert the amounts of the increased tax deficiencies or the amounts of the additions to tax or penalties. Respondent generally asserted the amounts of increased income or the amounts of disallowed expenses that would result in increased deficiencies in tax and additions to tax. As a result of these amended pleadings, and as a result of numerous concessions and stipulations of settlement which were effected by the parties before, during, and after the trial, as well as concessions of certain issues by respondent on brief, Rule 155 computations will be necessary in these cases.¹⁵

The parties settled several issues in these cases before and during the trial. In addition, the parties' objections and responses to the STJ report narrowed the issues remaining in dispute. The issues left to be decided are:

(1) Whether payments received by various entities associated with Kanter during the years at issue represent income earned by and properly taxable to Kanter, Ballard, and Lisle;

(2) if the Court sustains respondent's determinations that Kanter, Ballard, and Lisle are taxable on the payments in question, whether Kanter and Ballard are liable for additions to tax for fraud;

(3) whether commitment fees paid to Century Industries, Ltd., during 1981 to 1984 and 1986 represent income earned by and taxable to Kanter;

(4) whether Kanter received unreported income from Hi-Chicago Trust during 1981 to 1983;

(5) whether Kanter is taxable on income attributed to the Bea Ritch Trusts for 1986 and 1987;

(6) whether Kanter received unreported income from CMS Investors Partnership for 1982 to 1984 and 1987 to 1989;

(7) whether Kanter received unreported income from Equitable Leasing Co., Inc., during 1983;

(8) whether Kanter received unreported income for 1982 according to the bank deposits method of income reconstruction;

(9) whether Kanter received barter income from Principal Services Accounting Corp. during 1988 and 1989;

(10) whether the Kanters received unreported interest income during 1988;

(11) whether the Kanters are entitled to certain deductions they claimed on Schedules A and C for 1986 to 1989;

(12) whether Kanter realized and must recognize capital gains as a result of transactions involving Cashmere Investments Associates, Inc., during 1983, and whether Kanter is entitled to use the installment method for reporting purposes;

(13) whether Kanter is entitled to research and development and business expense deductions related to Immunological Research Corp. for 1979;

(14) whether Kanter received unreported partnership income during the taxable year 1978;

(15) whether the Kanters are entitled to a loss from GLS Associates for 1981;

(16) whether the Kanters are entitled to a loss from Equitec for 1983 and 1984;

(17) whether the Kanters are entitled to an investment interest expense deduction for 1981;

(18) whether the Kanters are entitled to an investment credit carryover of $120,566 for 1978;

(19) whether the Kanters are entitled to an interest deduction for 1986;

(20) whether the Kanters are entitled to a business deduction of $104,231 for 1980;

(21) whether the Kanters are entitled to a deduction for a charitable contribution to the Jewish United Fund for 1982;

(22) whether Kanter is liable for self-employment tax for the taxable year 1982;

(23) whether the Kanters realized capital gains and losses as reported on their tax return for 1987; and

(24) whether Kanter is liable for various additions to tax and increased interest for the years at issue.

IV. New Rule 183 and the Court's Review and Adoption Procedure

In their responses to respondent's objection to the STJ report, petitioners assert that the Court should ignore respondent's objections to the extent respondent (1) failed to make "specific, written objections" and merely rehashed proposed findings of fact and legal arguments from respondent's posttrial briefs, and (2) proposed new findings of fact (not contained in respondent's posttrial briefs). In connection with the foregoing, petitioners assert:

V. Standard of Deference Due to General Findings of Fact and Credibility Determinations Contained in the STJ Report

It is well settled that findings of fact and credibility determinations made by the judicial officer who presided over the trial of a case are presumed to be correct. Rule 183(d); Ballard v. Commissioner, 544 U.S. 40 (2005) (and cases cited therein). The axiom that deference must be given to the trial judge's findings of fact is rooted in the view that the trial judge (1) is uniquely positioned to evaluate the credibility of witnesses, (2) brings experience and expertise to the fact-finding process, and (3) is normally the person most familiar with the record in a case. Anderson v. City of Bessemer, N.C., 470 U.S. 564, 575, 580 (1985); see Fed. R. Civ. P. 52(a), Advisory Committee Notes (1985 amendment).

As previously discussed, the Courts of Appeals for the Eleventh Circuit and the Fifth Circuit remanded the Ballard and Lisle cases to this Court and directed that the recommended findings of fact in the STJ report are presumed to be correct "unless manifestly unreasonable". Respondent concedes that, although the Court of Appeals for the Seventh Circuit did not articulate a particular standard for review in its remand of the Kanter cases, the Court should apply the same "manifestly unreasonable" standard in all of the cases consolidated herein. Although respondent disagrees that the "manifestly unreasonable" standard is the appropriate standard to be applied under new Rule 183, we need not address the point in the context of these cases. We proceed with the review of the STJ report mandated by the Courts of Appeals and apply the "manifestly unreasonable" standard of deference as more fully described in the caselaw discussed below.

In Ballard v. Commissioner, 544 U.S. at 54-55, the Supreme Court addressed the deference that is due a Special Trial Judge's recommended findings of fact under Rule 183 as follows:

In Hebah v. United States, 197 Ct. Cl. 729, 456 F.2d 696, 698 (1972), the Court of Claims stated:

Our understanding of the standard of deference to apply to findings of fact and credibility determinations in the STJ report is further informed by the Court of Appeals for the Eleventh Circuit: "Credibility determinations are entitled to great deference, and must not be disturbed unless manifestly unreasonable." Ballard v. Commissioner, 429 F.3d at 1031 (citing Anderson v. City of Bessemer, N.C., supra at 575).

In Anderson, the Supreme Court granted certiorari to decide whether a Court of Appeals correctly rejected the trial court's findings of fact in support of a judgment in favor of a plaintiff in a sex discrimination case. The Supreme Court held the Court of Appeals misapplied the "clearly erroneous" standard of review governing a Court of Appeals' review of a District Court's findings of fact as set forth in rule 52(a) of the Federal Rules of Civil Procedure.¹⁸ Quoting United States v. United States Gypsum Co., 333 U.S. 364, 395 (1948), the Supreme Court stated that "'[a] finding is "clearly erroneous" when although there is evidence to support it, the reviewing court on the entire evidence is left with the definite and firm conviction that a mistake has been committed.'" Anderson v. City of Bessemer, N.C., 470 U.S. at 565. The Supreme Court embellished the "clearly erroneous" standard of review as follows:

A final point on the subject of deference. In Ballard v. Commissioner, 429 F.3d at 1031, the Court of Appeals for the Eleventh Circuit stated that the Tax Court's review and adoption of a Special Trial Judge's recommended findings of fact is analogous to a District Court's review of a magistrate judge's findings of fact, and, citing United States v. Cofield, 272 F.3d 1303, 1306 (11th Cir. 2001), it further stated that a magistrate judge's credibility determinations generally may not be rejected without rehearing the disputed testimony. Kanter's response to respondent's objections, filed under new Rule 183(c), includes an argument that the Court of Appeals for the Eleventh Circuit made it clear that this Court cannot reject the credibility determinations set forth in the STJ report. We disagree. We do not understand the Court of Appeals' statement to mean that we are barred from rejecting credibility determinations set forth in the STJ report without first rehearing the disputed testimony. Instead, the Court of Appeals observed that the deaths of primary witnesses in these cases foreclosed retrial. Ballard v. Commissioner, 429 F.2d at 1032. Rather than treating the credibility determinations as established on that account, the Court of Appeals prescribed the standard under which they are to be reviewed. Thus, we conclude we are not barred in these cases from rejecting credibility determinations recommended in the STJ report under the "manifestly unreasonable" standard of review described above.

VI. Structure of the Court's Report

After comparing the recommended findings of fact and legal conclusions in the STJ report with the entire record in these cases, and taking into account the parties' posttrial briefs and objections and responses filed pursuant to new Rule 183(c), we have determined to reject some of the recommended findings of fact in the STJ report because they are manifestly unreasonable and to supplement others because they are incomplete.

In constructing the Findings of Fact portions of this report, we have included many findings of fact drawn directly from the STJ report, and we have made additional findings of fact where necessary. For clarity, the findings of fact drawn directly from the STJ report appear in italics and are accompanied by page references to the STJ report.¹⁹ Footnotes taken from the STJ report likewise appear in italics but are renumbered. In contrast, the Court's additional findings of fact appear in bold type accompanied by supporting citations of the trial transcript, trial exhibit(s), and/or the parties' original posttrial briefs, as appropriate. Our departures from the recommended findings of fact in the STJ report normally are marked by a comment either in the text or in the margin (including appropriate citations of the record). See Ballard v. Commissioner, 429 F.3d at 1031. Any additions we have made in the findings of fact portions of this report that do not constitute findings of fact, such as headings and general commentary, appear in normal type.

The Opinion portions of this report appear in normal type and include (1) a summary of the legal analysis set forth in the STJ report, (2) an evaluation of the credibility determinations in the STJ report as weighed against the objective evidence drawn from the entire record, and (3) a discussion and analysis of each of the issues remaining in dispute.

Issue I. Whether Kanter, Ballard, and Lisle Earned and Are Taxable on the Income in Dispute

At the time the petitions were filed, the Kanters' legal residence was in the State of Illinois, the Ballards' legal residence was in the State of Florida, and the Lisles' legal residence was in the State of Texas. The independent coexecutors of the Estates of Robert W. and Donna M. Lisle, Amy L. and Thomas W. Lisle, were also legal residents of the State of Texas at the time they were substituted as representatives of the Estates of their deceased parents.

I. Petitioners²²

At the time of trial and for the past 10 years, Kanter taught courses in estate and gift taxation and estate planning at the University of Chicago Law School. Kanter has lectured and written extensively in the area of Federal tax law. He has also been an active participant in professional bar associations. For a number of years, Kanter has been a writer and contributor to the Journal of Taxation, a national monthly publication devoted exclusively to Federal taxation. One of the popular features of this publication is the Shop Talk section, which was originated and edited by Kanter. At the time of trial, Kanter was a senior editor with the Journal of Taxation. Kanter is generally recognized as renowned in his field. All of this has resulted in a successful and prolific law practice, which has led to Kanter's not only being engaged in the practice of law but also to his being extensively involved in consultation, development, and investments in a number of various business fields and enterprises.

Commensurate with his reputation as a highly successful and skillful tax lawyer, Kanter, over the years, has amassed an impressive array of business and professional clients and contacts in business and industry throughout the United States. For instance, Kanter has performed extensive legal work for the Pritzker family, majority owners of the Hyatt Corp., a major hotel company in the United States. He is and was a good friend of certain of the Pritzker family members, including the late A.N. Pritzker, the head of the Pritzker family, whom Kanter personally represented. Kanter also served as a director on several corporate and charitable organization boards.

Kanter has made many investments through numerous entities, including corporations, partnerships, and family trusts. Some of these family trusts are trusts the income of which is taxable to Kanter pursuant to the grantor trust provisions of sections 671 through 678. A number of Kanter's family trusts own substantial stock interests in The Holding Co., Inc., a corporation that made extensive investments during the years at issue.

Additionally, on occasion, Kanter and/or entities associated with him have entered into certain arrangements with various individuals, pursuant to which Kanter would use his business and professional contacts to assist such individuals either in obtaining potential business opportunities or in raising capital for business ventures. In exchange for such assistance from Kanter, these individuals agreed to share their profits or fees payable to an entity or entities associated with Kanter.²³

Petitioner Naomi R. Kanter, Kanter's wife, was not involved in any of the activities giving rise to this litigation. She is a petitioner in these proceedings solely because she filed joint Federal income tax returns with Kanter for the years at issue.

After paying a small amount of tax in 1978, Kanter paid no Federal income taxes during 1979 through 1989.²⁴ Kanter filed Federal income tax returns that reported adjusted gross income and income tax as follows:

            Adjusted Gross         Income

Essentially, Ballard's work with Prudential, in its real estate equity operations, involved the purchase and sale of existing properties, as well as the development of new properties. It included, additionally, the management of such properties, including the negotiation and sale of properties, where warranted. Ballard supervised the staff of this department at Prudential's headquarters, as well as the real estate department staff at Prudential's regional offices throughout the United States.

In his position with Prudential, Ballard met and was in contact with attorneys, developers, businessmen, and contractors involved in or affected by Prudential's acquisition and/or development, maintenance, operation, and financing activities. Ballard first met Kanter sometime in 1972 at Houston, Texas, in connection with the opening of the Houston Hyatt Hotel. As indicated previously, Kanter represented the Pritzker family, the majority shareholder/owners of Hyatt Corp. At the Houston Hyatt Hotel's opening, Ballard was introduced to Kanter by A.N. Pritzker (the head of the Pritzker family), who told Ballard that Kanter was A.N. Pritzker's "everything". In the succeeding years, Kanter and Ballard had numerous business and professional contacts with each other.

Petitioner Mary B. Ballard, Ballard's wife, was not involved, except in a very limited way, in any of the activities giving rise to this litigation. She is a petitioner in these proceedings solely because she filed joint Federal income tax returns with Ballard for the years at issue.

Lisle met Kanter sometime between 1968 and 1970. The two had numerous contacts with each other in succeeding years, including the period after Lisle left Prudential and worked for Travelers. The record does not reflect what outside business activity Lisle was involved with that would be relevant to these cases between the time Lisle left Travelers in April 1988 until his death in 1993.

Donna M. Lisle, Lisle's wife, was not involved in any of the activities giving rise to this litigation, and her estate is a party to these proceedings solely by virtue of Mrs. Lisle's having filed joint Federal income tax returns with Lisle for the years at issue. She died in 1993.

Ballard's high-ranking-executive position at Prudential allowed him to exert significant influence over Prudential's real estate investment decisions, including awards of property management contracts, financing transactions, and related business. Ballard, Transcr. at 215; Knab, Transcr. at 606-609; Strum, Transcr. at 511, 521-522. Ballard believed that his power to reject or veto a proposed transaction was the most significant power that he wielded at Prudential. Ballard, Transcr. at 215.

Lisle was authorized at both Prudential and Travelers to commit up to $20 million to real estate financing transactions and development projects. Exh. 2030, at 2, 9-10. Lisle's position at Travelers, senior vice president for the real estate investment department, was higher than his position at Prudential. Id. at 9. Lisle's high-ranking-executive positions at Prudential and Travelers allowed him to exert significant influence over Prudential's and Travelers' real estate investment decisions, including awards of construction contracts, financing transactions, development projects, and related business. Ballard, Transcr. at 215; Strum, Transcr. at 511, 521-522; Knab, Transcr. at 606-609.

IRA consistently filed annual franchise tax reports with the State of Delaware. Between 1974 and 1977, IRA was authorized to issue both common stock and several classes of preferred stock. Exhs. 4, 9071. IRA's annual franchise reports filed with the State of Delaware from 1975 to 1988 often were not accurate in reporting the shares of its stock that were issued and outstanding. Exhs. 4, 9071.

IRA has always had a board of directors and a full slate of officers. It has consistently filed Federal income tax returns.

During 1977 through 1989, IRA reported consolidated total income, taxable income/losses, and net operating losses as set forth in the following table:

                                Table 1

On October 28, 1975, Keating's 1,000 shares of IRA common stock were exchanged for 500 shares of class B preferred stock. Exh. 9051. Although she did not recall the fact, Schott held 1,200 shares of IRA class A preferred stock until 1982. Schott, Transcr. at 2113, 2129; Exhs. 10, 12, 14, 17. Schott held IRA stock to enable the company to hold a corporate real estate license. Schott, Transcr. at 2119; Exh. 4022.

On October 28, 1978, IRA issued 1,000 shares of common stock in equal shares to 25 trusts known collectively as the Bea Ritch Trusts. Exh. 9051; Exh. 135, at 23. By 1978, IRA redeemed Keating's 500 shares of class B preferred stock. Exh. 4.

During the examination of IRA's returns, an IRS agent recalled being presented with IRA corporate minutes for 1983 which indicated that IRA's shareholders at the time included the Bea Ritch Trusts, Schott, a Ballard family trust, and a Lisle family trust. Batory, Transcr. at 3151-3152.

Originally, when the 25 Bea Ritch Trusts were established in 1969, the beneficiaries of the Bea Ritch Trusts were Kanter, Kanter's family, and other relatives of Kanter. By about 1977, Kanter had purportedly renounced all of his interest as a beneficiary in the Bea Ritch Trusts.²⁶ Solomon Weisgal (Weisgal), an accountant and a longtime friend and business associate of Kanter, has been the sole trustee of the Bea Ritch Trusts since 1969. As trustee of the Bea Ritch Trusts, Weisgal has an extremely broad power either to accumulate the Bea Ritch Trusts' income or to distribute (i.e., sprinkle) the trusts' income and assets among all or any of the trusts' beneficiaries in virtually any manner he deemed appropriate.

On October 27, 1975, Schott was elected IRA's president, and Sharon Meyers (Meyers) was elected IRA's secretary. Id. Meyers had originally worked as Kanter's secretary. Meyers, Transcr. at 2890-2891. By the 1970s, Meyers's position at Kanter's law firm evolved to that of Kanter's administrative assistant. Meyers, Transcr. at 2894-2899. Meyers served as an officer and/or director of IRA at various times. Exh. 4.

From 1975 to 1980, Schott remained the president of IRA and Weisgal was vice president.²⁷ From 1980 to 1989, the president of IRA was Lawrence Freeman (Freeman), an attorney in Miami, Florida, and a friend and business associate of Kanter. Although Freeman was not paid for serving as IRA's president, Freeman and his law firm received significant legal business by referrals from Kanter. Although Freeman was IRA's president and director for most of the 1980s, he characterized his role as primarily that of a bookkeeper/accountant and administrator. Freeman, Transcr. at 1819.

In 1989, Kanter became IRA's acting president. Until 1989, Kanter had never been an officer or employee of IRA. Exhs. 4, 9071, 9085. Kanter and his law firm provided legal services to IRA. Gallenberger, Transcr. at 1990.

From 1976 through 1980, Schott, Weisgal, and Patricia Grogan (Grogan) served as IRA's directors. Exh. 4. Grogan was an accountant who began working at Kanter's law firm in the mid1970s. Grogan, Transcr. at 1395-1396. From 1981 through 1989, Freeman served as IRA's director. Exhs. 4, 9071.

Ballard and Lisle were never shareholders, officers, directors, or employees of IRA. Exh. 4. However, in December 1981, IRA issued a check to Ballard in the amount of $12,500 -- an amount identified in the memo section of the check as a director's fee. Exh. 3007. Ballard cashed the check, and IRA deducted the payment as a director's fee on its 1981 tax return. Id.; Ballard, Transcr. at 218; Exhs. 14, 9071.

IRA was primarily a vehicle for holding passive investments and generally had no paid employees. Meyers, Transcr. at 2911-2912; Petitioners' Reply Brief at 66. During the period 1983 to 1989, IRA did not claim any deductions for salaries, wages, or compensation paid to its officers. Exhs. 18-24.

Carlco, TMT, and BWK were so-called shelf corporations that Kanter first incorporated in 1982 but remained dormant until late 1983. Kanter, Transcr. at 3604-3605. In December 1983, IRA acquired 1,000 shares or 100 percent of the common stock of each of Carlco, TMT, and BWK. Exh. 18, at 7. IRA paid $6,000 to each of the corporations for the shares of stock. Exhs. 68, 92, 113.

In December 1983 and January 1984, Carlco, TMT, and BWK each issued preferred shares of stock. Carlco preferred shares were issued to the Christie Trust (Lisle's family trust); TMT preferred shares were issued to the Orient Trust (Ballard's family trust); and BWK preferred shares were issued to the BK Children's Trust (one of the Bea Ritch Trusts). As a result of those trusts' ownership of these preferred shares, Carlco, TMT, and BWK no longer qualified to be members of IRA's consolidated group of corporations for tax purposes and were not included in the consolidated returns IRA filed. For 1984 and thereafter, Carlco, TMT, and BWK, each filed separate Federal corporate income tax returns. The record does not include a complete set of Carlco's, TMT's, or BWK's corporate minutes books, stock ledgers, or stock registers after 1984.

During this period, Kanter recommended and proposed to Freeman (IRA's president) and Weisgal (trustee of the Bea Ritch Trusts, which held 100 percent of IRA's common stock) that generally Carlco and TMT should each receive a 45-percent share of IRA's available investment funds and that BWK should receive the remaining 10 percent of IRA's available investment funds.

Kanter testified that the distribution of IRA's funds to Carlco, TMT, and BWK in a 45/45/10 percent split represented (1) a "free-cashflow asset allocation" he and Freeman devised, and (2) an effort to diversify IRA's investments. Kanter, Transcr. at 3663-3666, 3690-3691, 3694-3695. The diversification of investments was to be achieved by having Lisle manage Carlco and invest principally in municipal bonds, Ballard manage TMT and invest principally in real estate, and Kanter manage BWK and make miscellaneous investments. Id.; Ballard, Transcr. at 222.³¹ Kanter, in fact, did not have time to manage BWK's investments. Kanter, Transcr. at 3695.

Kanter also testified that he recommended Carlco, TMT, and BWK be removed from IRA's consolidated group for tax-reporting purposes because (1) he was concerned that Carlco's earnings from tax-exempt municipal bonds might imperil IRA's interest deductions, and (2) he wanted to shelter Ballard and Lisle from "second-guessing" by Freeman or another IRA officer. Kanter, Transcr. at 3685-3686.³²Pursuant to Kanter's proposal, from 1984 through 1989, IRA transferred substantial funds and other assets to Carlco, TMT, and BWK in the respective 45-percent, 45-percent, 10-percent allocation. From 1984 through 1992, Ballard managed TMT's investments, and Lisle managed Carlco's investments.

THC was incorporated as a subchapter C corporation on December 8, 1976. Exh. 153. THC owned several subsidiary corporations including the Citra Co., Active Business Corp., Zion Ventures, Inc.,³⁴ Harbor Exchange Lending Operation (HELO),³⁵ LBG Properties, Inc., The Nominee Corp., Oil Investments, Ltd., and Tanglewood Properties, Inc. Exhs. 153, 154, 156-160. THC held numerous partnership interests during the period in question. Id.

Kanter did not report on his tax returns any sales of THC stock during the years at issue. Exhs. 120-134.

During 1981 to 1983, THC's officers and directors included Kanter, Weisgal, Meyers, Gallenberger, and Joshua Kanter. Exh. 152.

   TYE

By 1981, bookkeeping for IRA, THC, and other Kanter-related entities had become so voluminous that The Administration Co., Inc. (TACI), was organized for that purpose. Meyers, Transcr. at 2901, 2908-2909.³⁷TACI was incorporated in the State of Delaware on September 21, 1981, and was authorized to do business in the State of Illinois. Its articles of incorporation stated that it was "to engage in any lawful act or activity for which corporations may be organized under the General Corporation Law of Delaware." In TACI's application to do business in the State of Illinois, a more comprehensive statement of TACI's purpose was that the corporation would engage in consultant and advisory work, including investment, management, and advisory services. On the date TACI was incorporated, Weisgal, as trustee of the Pyramid Trust, subscribed to the total number of shares authorized to be issued by the corporation. Sharon Meyers was the Pyramid Trust's sole beneficiary. Sharon Meyers was the sole director of TACI and was its initial president and treasurer from 1981 through 1985.

TACI was organized to assist its clients in their financial and investment activities. TACI's clients included individuals, corporations, partnerships, trusts, various clients of Kanter, and members of his law firm. However, not all of the clients of TACI were clients of Kanter's law firm. At various times, TACI had hundreds of clients, including Kanter, IRA, and THC. From 1981 through 1988, TACI had between 200 to 500 clients.

TACI had several employees at any given time, mostly clerical assistants, bookkeepers, and accountants. TACI received moneys for and on behalf of clients and paid out moneys either to clients or to third parties on behalf of clients. TACI maintained books and records for each of these clients and, in many instances, prepared clients' tax returns. TACI charged a fee for its services.

With respect to moneys TACI collected and held for its clients, instead of having a separate bank account for each client, at the suggestion of the bank where TACI did business, a single bank account was opened, in TACI's name, which served as a common depository fund for all of TACI's clients. That account was known as the TACI Special E Account.³⁸ TACI's books and records reflected each client's balance of money in the account and also reflected the deposits or withdrawals by each client affecting that client's balance in the account. TACI also maintained at its bank another similar account known as the TACI Special Account, which was also for the benefit of TACI's clients. This account was not used as an operating account for TACI's clients but rather was used to pool or aggregate idle funds of TACI's clients. The moneys in this account were utilized generally to buy certificates of deposit because a higher rate of return could be realized for TACI's clients through aggregating their funds to purchase larger-denomination certificates of deposit. Funds from this account were also lent to other TACI clients. Deposits to and withdrawals from the TACI Special E Account and the TACI Special Account were posted to the appropriate client accounts. TACI issued annual tax statements and reports to its clients and the Internal Revenue Service on the interest income earned by each client on that client's funds in the TACI Special E Account and the TACI Special Account.

Kanter, as a client of TACI, had funds of his own in both the TACI Special E Account and the TACI Special Account. TACI, as part of its services and acting on Kanter's behalf, paid some of Kanter's business and personal expenses out of Kanter's funds in these accounts. All checks issued by TACI on behalf of a client were debited against the balance such client had in the accounts. If a client had a negative balance in the accounts, that debit amount was considered an indebtedness by the client to TACI. Any positive balance a client had in the accounts was considered money belonging and owed to said client.

Included among the services provided by TACI were bookkeeping services for its clients. This included keeping books and records for clients and the preparation of individual income tax returns. TACI prepared Kanter's income tax returns for all or some of the years at issue.

TACI's offices were located either at the law firm offices of Kanter or in close proximity thereto.

Meyers, who was president of TACI, directed the staff and employees of TACI until 1985. Linda Gallenberger (Gallenberger), a C.P.A., became vice president of TACI in 1982 and worked under the direction of Meyers. When Meyers left TACI, Kanter briefly served as acting president of TACI and, thereafter, Gallenberger became TACI's president from 1985 through 1988.

TACI employed several other clerical assistants, bookkeepers, and accountants, including Lisa Klopman Shanker (Shanker, Transcr. at 998), Sharon Bayers (Bayers, Transcr. at 1005-1006), Rosemary Snedden (Bayers, Transcr. at 1010), Rosaline Weiss (Weiss, Transcr. at 796), Phyllis Dassinger (Dassinger, Transcr. at 629-630), and Kim Moxely Roehn (Roehn, Transcr. at 967-968).

Kanter sometimes instructed Meyers, Gallenberger, and other TACI staff on how a particular transaction should be recorded, where a particular check should be deposited, or to whom moneys should be paid. Meyers, Transcr. at 2900, 2911 2934; Gallenberger, Transcr. at 1939, 1957.

Grogan maintained the books and records and prepared tax returns for IRA and THC. Grogan, Transcr. at 1400-1403, 14151417, 1476. Grogan also prepared Kanter's tax returns. Grogan, Transcr. at 1479-1480. Kanter instructed Grogan on how THC's assets were to be invested and how the tax returns for IRA and THC should be prepared. Grogan, Transcr. at 1421, 1479-1480.

TACI filed for bankruptcy in February 1988.³⁹ Lawrence Korrub served as TACI's bankruptcy attorney. Korrub, Transcr. at 1805. During TACI's 1988 bankruptcy proceedings, the records that TACI maintained for Kanter and Kanter-related entities were not turned over to Korrub. Korrub, Transcr. at 1807-1808. The only documents that Korrub received were copies of TACI's tax returns. Id. During TACI's bankruptcy, Gallenberger sent TACI's books and records, including the bank statements and canceled checks related to the TACI Special E and TACI Special Accounts, to Kanter. Gallenberger, Transcr. at 1970-1973.

At the time of TACI's bankruptcy, a new corporation, Principal Services Accounting Corp. (PSAC), was organized. All of PSAC's outstanding shares of stock were initially owned by ARO Trust, of which trust Kanter was the trustee. In 1989, Gallenberger became the president of PSAC. Gallenberger, Transcr. at 1978-1980. In 1990, Linda Gallenberger purchased from ARO Trust all of PSAC's shares for $100 and her assumption of PSAC's outstanding debts, which totaled over $100,000.

Prior to TACI's filing for bankruptcy, PSAC took over a number of TACI's clients, including Kanter, IRA, and THC. PSAC performed services for clients similar to those which TACI had provided to TACI's clients. For a short period in 1989, PSAC also established two accounts similar to the TACI Special E Account and the TACI Special Account.

The fees PSAC received from its clients were not sufficient to fund PSAC's operations. From the time PSAC came into existence in 1989 until the time Gallenberger purchased the stock of PSAC from the ARO Trust in 1990, PSAC borrowed over $100,000 from BWK and THC to pay its employees' salaries. Gallenberger, Transcr. at 1980-1982, 1987, 2041. BWK lent the money to PSAC either directly or through the TACI Special E Account. Gallenberger, Transcr. at 1983-1984.

Beyond 1990, PSAC did not generate enough fees to cover its operational costs, continued to operate at a loss, and borrowed money from BWK. Gallenberger, Transcr. at 1985-1986. At the time the record in these cases was closed, PSAC had not repaid the loans from BWK. Id. When borrowing money, Gallenberger either contacted Kanter about the loan or went ahead and borrowed the money herself. Gallenberger, Transcr. at 1986-1987.

PSAC's bookkeeping procedures and return preparation procedures were essentially the same as TACI's. Gallenberger, Transcr. at 1988-1989, 2078. Any questions that Gallenberger had regarding accounting matters were answered by Kanter or Freeman. Id.

PSAC was located at Kanter's law firm, Neal, Gerber & Eisenberg. George, Transcr. at 1282-1283. PSAC moved simultaneously with Kanter's law firm. George, Transcr. at 12831284.

II. Introductory Statement and Brief Introduction of The Five (STJ report at 24-28)

As the Court understands the case, respondent's claim of fraud is not based, per se, on the payments by The Five to Kanter or any of the other entities to which such payments were directed. The record is clear, and respondent does not challenge the fact, that all payments made by The Five were reported as income on the Federal income tax returns of the entities receiving such payments. Respondent's claim of fraud essentially is based upon (1) the failure of Ballard, Lisle, and Kanter to report, as income, amounts that were "dropped down" to them as loans that were never repaid, and (2) as to Kanter, for moneys he personally earned that he directed be paid to IRA or other entities he controlled and, as to which, Kanter failed to report on his individual income tax returns.

Respondent maintains that the failure of Kanter, Ballard, and Lisle to report the Prudential scheme, Travelers transaction, and Kanter transaction income constituted fraud under section 6653(b), for 1978 through 1989. The entities that make up The Five and a brief description of each follows:

(1) Hyatt Hotels Corp., a subsidiary of Hyatt Corp. (Hyatt). Hyatt manages hotels in the United States, Canada, and the Caribbean. As indicated previously, members of the Pritzker family control the ownership of Hyatt. Kanter represented the Pritzkers for years as their attorney. In 1979, IRA acquired KWJ Corp., a corporation that had been receiving certain "commission" payments from Hyatt on the management fees Hyatt earned in operating the Hyatt Embarcadero Hotel at San Francisco, California. The Hyatt Embarcadero Hotel had been developed and was owned by a joint venture in which Prudential was a participant. The commission payments, respondent contends, constituted part of the kickback scheme.

(2) Bruce J. Frey, D.M. Interstate, the B.J.F. Development Co. Partnership, and BJF, Inc. Bruce J. Frey was the principal in each of these latter entities. Mr. Frey, through these entities, managed apartments, office buildings, and commercial properties. He and these entities were also heavily involved in a number of condominium conversion projects in various cities around the country, in many of which Prudential held interests. Mr. Frey and his related entities shared certain fees with Kanter and his related entities, which respondent also contends constituted part of the kickback scheme.

(3) William D. Schaffel. Mr. Schaffel was a mortgage broker and real estate developer. Mr. Schaffel also assisted a New Jersey general contracting company to obtain certain construction contracts. From 1979 through 1986, he had extensive business dealings on behalf of individuals he represented with Prudential and Travelers. Mr. Schaffel shared with Kanter and his related entities brokerage and development fees, which respondent claimed was part of the kickback scheme.

(4) Property Management Systems, Inc. (PMS). The chairman and chief executive officer of PMS was Kenneth Schnitzer. PMS managed office buildings and other commercial real estate for others pursuant to property management contracts. A relatively small portion of its business included contract cleaning or janitorial services on some Texas commercial properties it managed. At one point, IRA acquired and owned a 47.5-percent stock interest in PMS. Certain fees of PMS were also shared with Kanter and his related entities, which respondent claimed was part of the kickback scheme.⁴⁰

(5) Essex Hotel Management Co. (Essex Partnership). The Essex Partnership had the following partners holding the partnership interests indicated:

                                         Percentage

As an initial matter, the STJ report stated that it was respondent's contention The Five made payments "In return for Ballard's and Lisle's services". This statement suggests that respondent asserted The Five were aware Ballard and Lisle were using their influence to steer business to them and The Five intended to compensate Ballard and Lisle for their actions. To the contrary, respondent's theory regarding the manner in which the kickback scheme was carried out is articulated in respondent's Opening Brief at 568-567, as follows:

The STJ report also incorrectly stated: "respondent's claim of fraud is not based, per se, on the payments by The Five to Kanter or any of the other entities to which such payments were directed." Respondent clearly asserted in his opening brief that Kanter's, Ballard's, and Lisle's actions were fraudulent because (1) they knew all the payments from The Five to IRA and THC represented income that was taxable to each of them individually, and (2) Kanter, Ballard, and Lisle intentionally used IRA and THC to (a) shelter the payments from The Five from taxation, and (b) to channel the payments to themselves disguised as capital contributions, loans, and payments to family members. Respondent's Opening Brief at 556-557.

In addition, the statement in the STJ report limiting respondent's theory of fraud to the failure of Kanter, Ballard, and Lisle to report as income amounts "dropped down" to them in the form of loans is inaccurate and incomplete. In fact, respondent claimed that Carlco, TMT, and BWK were owned by Lisle, Ballard, and Kanter, respectively, and, therefore, a much larger portion of the payments from The Five, a total of some $6.7 million, was transferred to Kanter, Ballard, and Lisle through so-called capital contributions to Carlco, TMT, and BWK. Id. at 459-473, 598-601. Though not to be ignored, the loans represented relatively small amounts of the moneys that respondent alleged were passed along from The Five, through Kanter-related entities, to Kanter, Ballard, and Lisle.

III. Details Regarding The Five

As indicated previously, by the middle of 1982, Ballard and Lisle each had left Prudential. After leaving Prudential, Lisle obtained a similar position at Travelers. Respondent's case for fraud is based upon payments made over several years from several entities and/or individuals that have been collectively referred to by respondent as The Five. The following narrative describes The Five and the nature of their payments.

Lisle also worked on the Houston Hyatt Hotel project for Prudential. Friend, Transcr. at 767-768, 772-777. A.N. Pritzker first introduced Kanter to Lisle as one of Hyatt Corp.'s representatives during the period 1968 to 1970 in connection with the Houston Hyatt project. Exh. 2030, at 10-11. Beginning in 1970, Lisle oversaw the development and construction of the Houston Hyatt Hotel as president of PIC Realty. Ballard, Transcr. at 115, 119; Exh. 2030, at 2.

During the early 1970s, before the Houston Hyatt Hotel was completed, Prudential was also participating in a joint venture to develop and own the Embarcadero Hotel in San Francisco. Along with Prudential, the other partners in the Embarcadero Hotel project were David Rockefeller, Trammel Crow, and John Portman (an architect). Ballard, Transcr. at 130; Friend, Transcr. at 759. As none of the joint venture participants possessed the experience, knowledge, and skill needed to manage and operate the hotel, they endeavored to have an experienced major hotel management company operate the hotel under a long-term management contract.

Lisle was supervising the Embarcadero Hotel's development for Prudential and was involved with Prudential and the other joint venture participants in the selection of a management company to manage the hotel. Del Webb, a well-known hotel operator and owner of a large hotel management company, and Intercontinental Co., another large hotel management company, were competing for the management contract.

A.N. Pritzker also was interested in having the Hyatt Corp. manage the hotel because the Embarcadero Hotel then would become the third or fourth Hyatt-operated hotel in the United States at which major conventions could be held. As a result of Ballard's experience in negotiating the Houston Hyatt Hotel's management contract, Knab (Ballard and Lisle's superior at Prudential) directed Ballard to review and evaluate the terms of the proposed management contracts to be considered for the Embarcadero Hotel. Kanter addressed some tax issues on behalf of Hyatt Corp. with regard to the Embarcadero Hotel. Kanter, Transcr. at 3669.

The Embarcadero Hotel was considered a spectacular property, and both Del Webb and A.N. Pritzker wanted the management contract for their respective companies. Ballard, Transcr. at 135-137, 142. Initially, Lisle was not interested in having Hyatt Corp. manage the Embarcadero Hotel. Lisle opposed Hyatt Corp.'s participation in the bidding on the Embarcadero Hotel management contract because A.N. Pritzker had recently paid John Portman to prepare a set of plans for another hotel in the Nob Hill area of San Francisco. Ballard, Transcr. at 135-137. However, Weaver, the Tenneco executive who had worked with Ballard in developing the Houston Hyatt Hotel, eventually persuaded Lisle to allow Hyatt Corp. to be considered for the Embarcadero Hotel's management contract.⁴²Weaver intervened with Lisle on behalf of Hyatt Corp. because A.N. Pritzker promised Weaver a 10-percent share of the "retained profits" Hyatt Corp. might earn managing the Embarcadero Hotel if Weaver could persuade Lisle to allow Hyatt Corp. to bid on the contract. Ballard, Transcr. at 127, 135-137;⁴³ Exh. 362.

Ballard recognized that Lisle alone held the power to bar Hyatt Corp. from bidding on the Embarcadero Hotel management contract, and there is no suggestion the other partners in the Embarcadero Hotel project had any direct input regarding the bidding process. Ballard, Transcr. at 130, 135-137.

Subsequently, Ballard, Lisle, other Prudential employees, and representatives of the other joint venture participants met with Del Webb and A.N. Pritzker to obtain their respective bids on the Embarcadero Hotel's management contract. The third bidder, Intercontinental Co., unexpectedly did not attend the bid meeting. Ballard, Transcr. at 136, 269. Ballard considered it unusual for Del Webb to attend such a meeting in person, as opposed to sending a representative. Ballard, Transcr. at 138.

During the meeting, Mr. Webb refused to submit a bid on behalf of his hotel management company, as Mr. Webb claimed that it was his understanding that Mr. Webb's company was to receive the management contract. Although Lisle and other representatives of the joint venture participants then asked Mr. Webb how he believed this was so, Mr. Webb refused to elaborate. A.N. Pritzker offered to have Hyatt Corp. enter into a management contract for the Embarcadero Hotel substantially similar to the Houston Hyatt Hotel's management contract. As Hyatt Corp. submitted the only bid, A.N. Pritzker's proposal was accepted, and a management contract for the Embarcadero Hotel along those lines was ultimately entered into by Hyatt Corp., Prudential, and the other joint venture participants. Hyatt Corp. was awarded the Embarcadero Hotel management contract without any competing bid. Ballard, Transcr. at 136.

KWJ Corp. was an S corporation solely owned by Weaver. In early 1971, shortly after winning the Embarcadero Hotel management contract, Hyatt Corp. entered into a "Memorandum Of Agreement" with KWJ Corp. (the Hyatt/KWJ agreement), whereby Hyatt Corp. agreed to pay KWJ Corp. an annual commission generally equal to 10 percent of Hyatt Corp.'s "net cash profits" from the Embarcadero Hotel management contract. The Hyatt/KWJ agreement stated: "KWJ has been the principal factor in bringing the parties together and aiding in the negotiations" with regard to the Embarcadero Hotel management contract. Exh. 362, at 2.

The Hyatt/KWJ agreement purportedly was authorized by Hyatt Corp.'s executive officers under a document entitled "Certificate of Secretary", which bore the signature of Hugo M. Friend, Jr. (Friend), an executive vice president, secretary, and director at Hyatt Corp. during the period in question. Exh. 362; Friend, Transcr. at 748-749, 753. Friend's sister was married to Jay Pritzker, one of A.N. Pritzker's sons. Friend, Transcr. at 750.

The Certificate of Secretary stated that a special meeting of Hyatt Corp.'s executive committee of the board of directors had been held, and a resolution was adopted authorizing Hyatt Corp. to enter into an agreement with KWJ Corp. "for KWJ's services rendered in connection with * * * [Hyatt Corp.'s] entering into a lease" with regard to the Embarcadero Hotel. Exh. 362. Friend first learned of the Hyatt/KWJ agreement well over a year later, in June 1972, and he was surprised to see that his name had been signed on the document. Friend, Transcr. at 752-755. Friend investigated further and learned that Donald Pritzker, another of A.N. Pritzker's sons and president of Hyatt Corp. at the time, had his secretary, Joanne Brown, sign Friend's name on the document. Friend, Transcr. at 754. Friend also learned the agreement was entered into because of Weaver's substantial influence in obtaining the Embarcadero Hotel management contract for Hyatt Corp. Friend, Transcr. at 764. Another Hyatt Corp. document, a "Memorandum To The Files", prepared by Leonard W. Stoga, Hyatt Corp.'s chief financial officer, dated February 27, 1982, stated that Weaver earned the fee "as a result of arranging the management agreement between Hyatt * * * and Prudential." Exh. 464; Stoga, Transcr. at 804-807.

Following the Embarcadero Hotel deal, Hyatt Corp. abandoned the Nob Hill hotel project. Ballard, Transcr. at 135-137. Prudential later built 8 to 10 Hyatt hotels in cities including New Orleans, Cambridge (Massachusetts), Indianapolis, Nashville, Chicago, and Oahu, Hawaii. Ballard, Transcr. at 135; Friend, Transcr. at 770-771. Friend often conferred with Ballard and/or Lisle when Hyatt Corp. contemplated replacing a hotel manager at a Prudential-financed hotel. Id.

Kanter purportedly met Ballard and Weaver for the first time in the fall of 1972 at the opening of the Houston Hyatt Hotel. Kanter, Transcr. at 3602-3603, 3652; Friend, Transcr. at 759.⁴⁴

Kanter testified he first learned of Hyatt Corp.'s agreement to share its fees on the Embarcadero Hotel's management contract with KWJ Corp. in about 1973, when A.N. Pritzker asked Kanter to review the agreement.

Ballard testified he learned of the Hyatt/KWJ agreement from A.N. Pritzker, after the fact and in connection with discussions regarding the other Prudential-financed hotels mentioned above. Ballard, Transcr. at 134-135. Ballard testified that A.N. Pritzker volunteered that Hyatt Corp. paid a finder's fee to Weaver on the Embarcadero Hotel, but A.N. Pritzker sought to assure Ballard that Hyatt Corp. did not pay finder's fees on its management contracts. Id.

In early 1975, a dispute arose between Weaver and Hyatt Corp. with regard to the commission due to KWJ Corp. for 1974. Friend informed Weaver that the Embarcadero Hotel did not generate a net profit for 1974. Exh. 9101. Weaver wrote to Friend and claimed that Hyatt Corp.'s revenue from the Embarcadero Hotel for 1974 under its management contract with Prudential was $612,201 and that KWJ Corp. was entitled to 10 percent of that amount. Id. A.N. Pritzker responded to Weaver by letter and asserted that KWJ Corp.'s share of the fees would have to be reduced by a share of Hyatt Corp.'s home office expenses. Exh. 9102. Weaver wrote back to A.N. Pritzker disagreeing with this approach. Exh. 9103.

During 1975, A.N. Pritzker brought the Hyatt/Weaver dispute to Kanter's attention and requested his advice. Kanter, Transcr. at 3646-3650. During this period, Kanter and Weaver discussed and negotiated Mr. Weaver's sale of KWJ Corp. to Kanter's "client", IRA. Following these negotiations, in his letter to Kanter dated March 10, 1976, Mr. Weaver confirmed "our understanding regarding my granting to your client a right [option] to purchase all of the outstanding shares of stock of KWJ Corp." for $150,000 and Mr. Weaver's continuing right to receive an amount equal to 30 percent of the payments KWJ Corp. received from Hyatt Corp. on the Embarcadero Hotel's management contract.⁴⁵

Kanter testified that Weaver agreed in the mid-1970s to sell KWJ Corp. to IRA for $150,000 because he needed the money. Kanter, Transcr. at 3652-3653. There is no indication in the record that the option Weaver granted to Kanter had any independent value -- Weaver simply granted IRA an open-ended option to purchase KWJ Corp. for $150,000. Exh. 9103. As discussed below, IRA's purchase of KWJ Corp. was delayed until 1979 after Hyatt Corp. had become a privately held corporation.⁴⁶

In the meantime, correspondence from Hyatt Corp. to Weaver shows that (1) Hyatt Corp. revised its Embarcadero Hotel management contract with Prudential sometime in late 1975, (2) a question arose whether KWJ Corp.'s commission would be computed under the old Embarcadero Hotel management contract or the new Embarcadero Hotel management contract, (3) Hyatt Corp. paid KWJ Corp. $54,848 for 1976 and $60,739 for 1977,⁴⁷ and (4) Weaver was informed in 1978 that the Embarcadero Hotel's performance was improving and commission payments to KWJ Corp. would be increasing. Exh. 364; Exh. 9103, at 12; Exh. 4003.

By letter dated September 27, 1979, Kanter informed Weaver that IRA wanted to proceed with the purchase of KWJ Corp., effective retroactively to November 1, 1978. Exh. 365. In 1979, IRA purchased 100 percent of KWJ Corp.'s outstanding shares of stock from Mr. Weaver. Specifically, IRA issued to Weaver a $150,000 promissory note which provided that Weaver was to be paid $10,000 on or before November 30, 1979, and $140,000 (with interest at 12 percent) on or before July 31, 1980. Exh. 9103, at 29. On November 26, 1979, 4 days before IRA was obliged to pay Weaver $10,000 in cash on the note, Grogan, on behalf of IRA, sent Weaver a letter requesting that Weaver accept "a note of a third party, International Films, Inc." (IFI), one of IRA's subsidiaries, reflecting an obligation due from IFI to IRA in full payment of the $10,000 amount due. Exh. 9103, at 30. Weaver agreed to this proposal. On November 30, 1979, Grogan, on behalf of IRA, sent Weaver a document purporting to be an IFI note payable to IRA for $10,000 which was assigned to Weaver. Exh. 9103, at 31-32. On March 12, 1980, Meyers, on behalf of IFI, sent a letter to Weaver requesting that he agree to extend to July 1, 1980, the time in which IFI had to pay him $10,000. Exh. 9103, at 36. On July 2, 1980, IFI purportedly paid Weaver $10,907.37 by check signed by Grogan. Exh. 9103, at 37. (The record does not reflect whether this check was negotiated.) On August 1, 1980, Kanter sent Weaver a letter purportedly forwarding a check in the amount of $154,176.44 for the stock of KWJ Corp. Exhs. 9103, 38. (The record does not reflect whether this check was negotiated.)

The fact that Weaver did not receive payment on his sale of KWJ Corp. to IRA until August 1980 casts serious doubt on Kanter's testimony that Weaver agreed to sell KWJ Corp. for $150,000 in 1976 because he needed the money. Kanter, Transcr. at 3652-3653.

As a result of IRA's purchase, KWJ Corp. was included as a subsidiary on IRA's 1979 consolidated tax return. Exh. 10, at 7, 19. IRA's 1979 consolidated return reflected KWJ Corp.'s assets, liabilities, and net worth as of January 1, 1979, as follows:

 Assets                             Amount

KWJ Corp.'s accrued income of $108,521 as of January 1, 1979, nearly equaled the sum of the $54,848 and $60,739 ($115,587) payments that KWJ Corp. received from Hyatt Corp. in 1976 and 1977, respectively. Exh. 9103, at 12; Exh. 4003. IRA's 1979 consolidated return reported that KWJ Corp. had gross receipts of $171,027 for 1979, and $51,308 of that amount (the 30 percent paid to Weaver) was deducted as a commission expense. Exhs. 10, 4003. IRA's share of the 1979 Hyatt Corp. payment alone provided IRA with nearly the full $150,000 purchase price for KWJ Corp. KWJ Corp.'s contract with Hyatt Corp. was worth millions of dollars. Exh. 4003. By selling KWJ Corp. to IRA, Weaver gave up 70 percent of his contract rights under the Hyatt/KWJ agreement.

Neither Weaver nor Kanter immediately informed Hyatt Corp. that IRA had purchased KWJ Corp. Handelsman, Transcr. at 11361137. Consequently, Hyatt Corp. continued to send to Weaver checks made payable to KWJ Corp. Handelsman, Transcr. at 11361137; Stoga, Transcr. at 813. From 1977 through 1994, Hyatt Corp. paid KWJ Corp. approximately $2.5 million pursuant to the Hyatt/KWJ agreement. Exhs. 4003, 465, 466, 467, 378, 380, 381; Stoga, Transcr. at 808-811; Handelsman, Transcr. at 1141, 11431144. Weaver forwarded each of the Hyatt Corp. payments to Kanter. Exhs. 4003, 373, 9103 (e.g., Weaver letters to Kanter dated March 29, 1983, and March 12, 1984). Kanter then returned 30 percent of the Hyatt Corp. fees to Weaver, and IRA deducted those payments as a commission expense. Exh. 10, at 16; Exh. 14, at 7; Exh. 17, at 15-16; Exh. 18, at 20; Ex. 9103 (e.g., TACI check to Weaver dated March 27, 1984).

By letter dated March 29, 1983, Weaver forwarded to Kanter the most recent payment from Hyatt Corp. Weaver's letter stated in pertinent part:

Neither Weaver nor Kanter immediately informed Hyatt Corp. that KWJ Corp. had been liquidated. Exh. 9104; Handelsman, Transcr. at 1136-1137. Consequently, Hyatt Corp. continued to send to Weaver checks made payable to KWJ Corp. Id.

Beginning in 1984, the Hyatt Corp. payments that Weaver continued to forward to Kanter were no longer reported on IRA's consolidated returns. Rather, Carlco, TMT, and BWK reported their distributive shares of this money passed through to them from KWJ Partnership. Exhs. 69-74 (Carlco general ledgers); Exhs. 93-98 (TMT general ledgers); Exhs. 114-119 (BWK general ledgers).

In August 1992, after the IRS began its examination in these cases, Kanter informed Hyatt Corp. that IRA had purchased and later liquidated KWJ Corp., and that KWJ Corp.'s assets were transferred to Carlco, TMT, and BWK and then contributed to KWJ Partnership. Exh. 9104. As of the time of trial, Hyatt Corp. continued to send its payments to Weaver in the form of checks made payable to KWJ Corp. Handelsman, Transcr. at 1137.

During the period 1977 to 1994, Hyatt paid to KWJ Corp. the amounts set forth in the following table.⁴⁸

       Table 2

As discussed in detail in additional findings of fact, infra pp. 192-194, KWJ Corp., and later KWJ Partnership, paid substantial amounts to Ballard's and Lisle's adult children during the period 1982 to 1989, and those amounts were deducted as consulting fees.

On June 15, 1984, Frey, Wold, and BJF, Inc., as general partners, and TSG Holdings, Inc., FWID, Ltd., and THC formed a limited partnership known as BJF Development, Ltd. (BJF Partnership), to engage in condominium conversion projects and related business. Exh. 223. BJF Partnership is discussed in greater detail below.

In many instances, Frey's limited partnerships acquired an apartment complex, renovated and converted it into condominium units, and sold the condominium units to individual purchasers. Frey explained that he purchased apartment buildings at their rental value and, after refurbishing and converting the apartments to condominium units, he was able to turn a profit by selling the units to individual owners. Frey, Transcr. at 659. Frey and/or another entity owned by him also typically earned certain development and management fees on condominium conversions. The development fees were for Frey's and/or his entity's services in managing and supervising the renovation and conversion work on the property, and the management fees were paid for their services in assisting the property's condominium association manage the property following the property's conversion.

After successfully engaging in his first condominium conversion project in Illinois in 1978 known as Moon Lake Village, Frey consulted with Kanter to obtain tax advice in connection with that project. Kanter was not involved as an investor or partner in the Moon Lake Village project. Frey, Transcr. at 662-663. During their meeting or shortly thereafter, Frey and Kanter discussed Frey's pressing need to raise capital for future condominium conversion projects. At that time, a condominium conversion craze was occurring in a number of major metropolitan areas throughout the country, and Frey was faced with having to raise large amounts of capital to acquire and convert apartment building properties in which he and other competing condominium converters were interested. Although Frey generally could obtain financing from a bank for most of a condominium conversion project's cost, the bank typically would require Frey and other investors to have a substantial investment in the project. Kanter indicated that he could help raise large portions of the capital that Frey needed for such condominium conversion projects.⁵⁰ However, Kanter stated, in return for such assistance, he would have to receive a share of any development and management fees that Frey earned from such projects.

Kanter made it clear to Frey that he would bring additional investors and capital to Frey's projects only if Frey agreed to pay Kanter a share of the fees that Frey earned for a given project. Kanter told Frey: "I want to be on the same basis as you. Whatever fees you participate in, I don't want you to have an edge; if I am going to bring capital in and add value to these partnerships, I don't want anyone to have an edge and I want to participate in those fees." Frey, Transcr. at 671. Frey acknowledged that Kanter "had a role of more than just a passive investor. His role was bringing in capital into the venture." Frey, Transcr. at 668.

Beginning in 1979-80 with Frey's second and third condominium conversion projects known as Lakewood and 535 North Michigan Ave., respectively, entities associated with Kanter invested, as limited partners, in a number of Frey's condominium conversion projects. The entities associated with Kanter that invested in these condominium projects included Zeus Ventures, Inc. (Zeus), a subsidiary of IRA, and Zion Ventures, Inc. (Zion), a subsidiary of THC. Following through on his oral agreement with Frey, Kanter also brought other investors and capital to the Lakewood and 535 North Michigan Ave. projects.⁵¹ Frey, Transcr. at 663-674; Wold, Transcr. at 2880. Kanter brought in the Marmon Trust as a major investor in the 535 North Michigan Ave. project. Frey, Transcr. at 666, 673.

In return for Kanter's bringing investors and capital to the Lakewood and 535 North Michigan Ave. projects, Frey paid Kanter 10 to 20 percent of the development and management fees Frey earned on those projects. Frey, Transcr. at 665-668; Wold, Transcr. at 2865. Frey remitted these payments to Kanter-related entities as directed by Kanter. Frey, Transcr. at 674; Wold, Transcr. at 2861. At the same time, Zeus and Zion received normal profits interests as limited partner investors in these projects. Frey, Transcr. at 666.

Prudential was not involved in either the Lakewood or the 535 North Michigan Avenue conversion projects. Frey, Transcr. at 663- 677.

The first condominium conversion project that Frey undertook involving Prudential was in connection with a 1,000 unit townhouse apartment complex called Village of Kings Creek at Miami, Florida. In late 1979 or early 1980, Frey approached a Prudential real estate department executive working in Prudential's Miami, Florida, regional office about purchasing the Village of Kings Creek apartment complex. The apartment complex was owned by a pension fund managed by Prudential. Frey offered to purchase the apartment complex for a cash price of about $20 million. He also advised the Prudential executive that another insurance company, Connecticut Mutual Life Insurance Co., would be joining Frey in purchasing the property. Prudential had already considered selling the apartment complex, and Frey's $20 million offer for the property significantly exceeded the property's appraised market value.

The Prudential executive consulted with Ballard about Frey's offer. Ballard advised the executive that Prudential, acting on the pension fund's behalf, should accept the offer, as Ballard felt that Prudential's refusal of such an offer might constitute a breach of fiduciary duty as investment manager of the pension fund.

In 1980, Prudential sold the Village of Kings Creek apartment complex to a limited partnership Frey organized to undertake conversion of the property to condominiums. Zeus and Zion participated as limited partners in this partnership, contributing $100,000 and $108,014, respectively, to the Village of Kings Creek partnership. Exh. 5800. Kanter also brought in another investor, First Illinois Enterprises, that made a substantial investment in the project. Wold, Transcr. at 2854.

During the Village of Kings Creek conversion process, Ballard visited the property "to see what was going on down there", and he met Wold. Ballard, Transcr. at 178. During this same period, Kanter introduced Frey to Ballard at Prudential's headquarters in Newark. Ballard, Transcr. at 173-175.

The Village of Kings Creek condominium conversion project was successful. The Village of Kings Creek partnership made a distribution to its partners to cover the partners' share of tax liabilities. Wold, Transcr. at 2854-2855. In addition, Kanter received a share of development fees earned on the project by way of checks made payable to THC. Exh. 457; Wold, Transcr. at 2855, 2860-2861. Wold believed Kanter directed that the checks should be written to THC. Wold, Transcr. at 2861.

Following Frey's success with the Village of Kings Creek project, the Miami regional office Prudential executive who Frey had dealt with in purchasing that property approached Frey about acquiring another Prudential apartment property in Florida. Beginning with this property, Prudential ultimately participated in a number of successful condominium conversion projects with Frey. However, many, if not almost all, of these projects that Frey and Prudential undertook were joint ventures. Entities associated with Kanter, including Zeus and Zion, also were investors in a number of these joint venture condominium conversion projects of Frey and Prudential. Frey did not have to raise as much capital to engage in these joint venture projects with Prudential, as Prudential already owned the apartment property to be converted and sold to individual condominium unit owners. Rather than Prudential's selling an apartment property to Frey and other investors, Prudential elected to participate as co-owner in a joint venture to convert and sell the property as condominium units. Prudential would contribute the property and receive (1) all initial condominium unit sale proceeds up to a specified amount based, in large part, on the property's appraised fair market value as a rental property, and (2) 50 percent of all other unit sale proceeds above the initial specified amount. Frey and other investors would usually form a limited partnership and were responsible for renovating and converting the property and selling the condominium units. The limited partnership that included Frey and other investors received the other 50-percent share of all unit sales proceeds above initial specified amount of the sales proceeds. Frey and/or an entity owned by him also earned development and management fees from the project.

Frey/Prudential joint venture projects included condominium conversions known as The Greens, Chatham, Calais, Valleybrook, and Old Forge. Frey, Transcr. at 677; Wold, Transcr. at 2868. Prudential and BJF, Inc., entered into a series of consulting agreements with regard to these projects between August 1, 1981, and December 1981. Exh. 223, app. A, pt. II, items 13, 16, 19; Exhs. 221, 5814. Kanter received a share of development fees in connection with each of the Prudential joint venture condominium conversion projects listed above through checks made payable to Zeus. Exh. 457; Wold, Transcr. at 2868-2870.

Kanter (through payments to Zeus) also received a share of the fees Frey earned with respect to a Prudential condominium project known as Galaxy Towers, a building that Lisle's PIC Realty had constructed. Exh. 457, at 2, 4, 8; Exh. 2030, at 25. Although Prudential converted the Galaxy Towers to condominiums on its own, Prudential hired Frey to serve as a consultant for the conversion and to begin a marketing plan to sell the condominiums. Frey, Transcr. at 684-685. In exchange for these services, Frey's company received consulting fees. Id. In January 1982, Prudential and BJF, Inc., executed a consulting agreement regarding the Galaxy Towers. Exh. 223, app. A, pt. II, at 8, No. 22.

In the interim, on October 12, 1981, the existing agreement that Frey had to share development and management fees with Kanter was formalized in two separate written agreements.⁵² One agreement was between BJF, Inc., and IRA's subsidiary, Zeus, and the other agreement was between BJF, Inc., and THC. These written agreements covered projects in which Prudential apartment properties were being converted, as well as other projects not involving Prudential's apartment properties.

The Frey/Zeus participation agreement formalized Frey's and Kanter's prior oral agreement to share development fees and extended that agreement to cover assigned profits on Prudential projects.

Consistent with Frey's oral agreement with Kanter, as subsequently formalized in the Frey/THC agreement and the Frey/Zeus agreement, BJF, Inc., remitted monthly, and later quarterly, payments to Kanter during the period December 1981 to late 1984, representing THC's and Zeus's shares of development fees and assigned profits arising from condominium conversion projects at Village of Kings Creek, Calais, Chatham, and Valleybrook. Exhs. 224, 225, 228 (checks written against a D.M. Interstate Management, Inc. account).

A letter to Kanter from BJF, Inc., dated October 31, 1983, stated in pertinent part:

THC did not make any direct cash contributions to BJF Partnership when it acquired its limited partnership interest. A June 20, 1984, letter to Kanter from a law firm involved in the matter indicated (1) THC was obliged to make a $29,913 cash contribution to the partnership, (2) THC owed $86,789 to FWID for making cash equivalent contributions on THC's behalf, and (3) THC should issue a secured note to FWID in the amount of $88,387 for contributing other assets to the partnership's capital on THC's behalf. Exh. 5802. On December 31, 1984, however, TSG Holdings purchased additional interests in BJF Partnership from THC and the other partners. Exhs. 5804, 5806, 5808. THC's share of the payments made by TSG Holdings totaled $241,951, and THC actually received $197,757 of that amount (with $44,194 having been remitted to Frey in repayment of a portion of the amount that Frey had contributed to the partnership on THC's behalf.) Exhs. 5809, 5811.

During the period October 1984 to July 1987, BJF Partnership issued separate checks to THC representing (1) shares of development fees for Village of Kings Creek, and (2) partnership distributions attributable to its limited partnership interests. Exhs. 226, 457. During the same period, BJF Partnership issued checks to Zeus representing (1) shares of development fees and incentive payments attributable to Prudential condominium conversion projects at Galaxy Towers, Calais, Chatham, and Valleybrook. Exhs. 227, 457.

                        Table 3

                  Table 4

During the dinner, no business involving Prudential was discussed by Kanter, Ballard, Lisle, and Schaffel. Although Prudential business may not have been discussed at the dinner, Lisle recognized that Kanter's motivation for arranging the dinner was to see whether Schaffel might be able to do business with Prudential in the future. Exh. 2030, at 24. During the dinner, Kanter asked whether Schaffel would be interested in arranging the financing for a casino hotel to be built in Atlantic City, New Jersey. Prudential was not involved in the casino project. When Schaffel expressed interest, Kanter told Schaffel that, in return for Kanter's assistance to Schaffel in obtaining the contract to do the casino's financing, Kanter would have to receive 50 percent of Schaffel's fees on the project.⁵⁴

Although the Atlantic City casino project fell through, Schaffel subsequently had substantial business dealings with Prudential on behalf of certain individuals he represented. These business dealings included construction contracts that he helped obtain for Torcon, Inc. (Torcon), and financing for a number of large commercial real estate properties being developed by William Walters (Walters), a real estate developer in Denver, Colorado.

After the dinner meeting with Kanter, Ballard, and Lisle, Schaffel agreed to split with Kanter any brokerage fees that he might earn on Prudential-related transactions. Schaffel, Transcr. at 384- 386. However, to protect his interests as a real estate broker, Schaffel insisted that Kanter's share of those fees be paid to an individual or entity with a real estate broker's license. Schaffel, Transcr. at 393. Kanter in turn directed Schaffel to make the payments to IRA, which held a corporate real estate broker's license through Schott, IRA's president at the time. Id.; Schott, Transcr. at 2119; Exh. 4022.

As discussed in detail below, between 1979 and 1983, Schaffel shared with IRA fees from business deals with Prudential. Some of the fees Schaffel and IRA shared were Prudential deals that took place after Ballard and Lisle had left Prudential.

After 1979, Torcon was awarded Prudential construction contracts referred to as the Parsippany Business Campus, Parsippany Hilton Hotel, Gateway Office Complex, and Princeton Interplex Complex. Torcivia, Transcr. at 362. Torcivia met Lisle at the groundbreaking for the Parsippany Hilton Hotel in 1980. Torcivia, Transcr. at 363-364.

On November 5, 1981, Barbara DiLanciano sent a letter to Schaffel, on behalf of IRA, regarding the Ramada Renaissance and Cherry Creek Place II development projects, which stated: "this letter will serve as your notification and restatement of our arrangement wherein * * * [IRA], as your broker, is to receive one- half of the financing fee due you." Exh. 471. Prudential committed to provide $17 million and $15.6 million in financing for the Ramada Renaissance and Cherry Creek Place II projects, respectively. Exhs. 189, 190.

On December 12, 1982, Walters and Schaffel entered into two written agreements which provided that Schaffel would receive fees of 1 percent of the aggregate financing that Walters obtained from Travelers with regard to development projects referred to as Cherry Creek National Bank and Stanford Place II. Exh. 195 (Cherry Creek National Bank); Exh. 196 (Stanford Place II). The Walters/Schaffel fee agreement pertaining to Cherry Creek National Bank was printed on Kanter & Eisenberg law partnership letterhead. Exh. 195.

In November 1983, Walters and Schaffel entered into four additional written fee agreements which provided that Schaffel would receive a fee of 1 percent of the aggregate financing that Walters obtained from Travelers with regard to four separate development projects. Exh. 193 (17th & Market Plaza); Exh. 197 (Orchard Place VIII); Exh. 198 (Orchard Place VII); Exh. 199 (Cherry Creek Building III). The record reflects that Lisle personally approved Travelers financing for several of these development projects. Exhs. 990, 993, 995.

By check dated November 9, 1983, Schaffel paid $213,750 to IRA representing 50 percent of the fees that Schaffel earned on the Stanford Place II project.⁵⁵ Exh. 204, at 2. After the Stanford Place II payment, however, Schaffel stopped paying IRA on Travelers transactions, and a dispute with Kanter followed.

Sometime during 1984, Kanter contacted Schaffel and inquired why IRA was not receiving 50-percent of Schaffel's fees on Travelers deals. Schaffel took the position that the August 2, 1979, agreement between himself and IRA did not apply to deals with Travelers because Lisle had left Prudential. Schaffel was concerned that the terms of his agreement with IRA were too comprehensive and costly. Schaffel explained: "Bob [Lisle] had moved on to Travelers and Claude [Ballard] had moved on to Goldman Sachs and I was no more dealing with The Prudential." Schaffel, Transcr. at 395. However, Kanter disagreed and maintained the August 2, 1979, agreement continued to apply.

In a letter dated August 28, 1984, to Schaffel, Kanter stated, in pertinent part:

Lisle also discussed with Schaffel the dispute between Schaffel and Kanter.⁵⁶ Although Lisle indicated that he did not care about any arrangement between Schaffel and Kanter and did not want to become involved in their apparent dispute, Lisle expressed concern about a possible lawsuit being brought, and such a lawsuit might cause some difficulty for Lisle at Travelers.

Schaffel and Kanter eventually settled the dispute by agreeing that (1) Schaffel was obliged to share fees with Kanter only if he did business with Travelers, and (2) those fees would be remitted to a new Kanter-related entity, THC. From 1984 through 1986, pursuant to the agreement, Schaffel paid a share of his fees on business deals with Travelers to THC. Schaffel, Transcr. at 396-399; Exh. 203; Exh. 206, at 1. The record does not reflect the identity of the THC officer who held a real estate broker's license.

                     Table 5

   Date     Walters's Project       IRA          THC          Exhibit

There is no evidence in the record that anyone representing or acting on behalf of IRA or THC was "instrumental or helpful" in obtaining financing from Prudential or Travelers for Walters's development projects or in arranging Prudential construction contracts for Torcon.

                                                  Percentage

On May 3, 1982, Kanter wrote a letter to Schaffel which stated in pertinent part:

In 1982, Kanter transferred his 8-percent limited partnership interest in One River Partnership to FPC Subventure Partnership in exchange for a promissory note of $2,000. Exh. 915.

Tax effects aside, during the period 1981 to 1989 Lisle received at least $682,520 in cash distributions from FPC Subventure Partnership.⁶⁰ Exhs. 9090-9094, 417-421. Consequently, FPC Subventure Partnership served for Lisle the dual purposes of (1) a tax shelter, and (2) a source of substantial cashflows.

In 1974, Century Development Corp. (Century), a subsidiary of Century Corp., Schnitzer's family holding company, acquired for a price of $1.2 million a small real estate management company called Fletcher Emerson Co., Inc., whose name shortly thereafter was changed to Property Management Systems, Inc. (PMS). Ross, Transcr. at 1213-1214.⁶¹ Previously, Schnitzer had been involved in developing and managing high-rise office buildings through Century. By acquiring PMS, Century expected to diversify its operations and to secure a steady source of earnings, because the real estate development business it also engaged in typically was cyclical.

When Century purchased PMS in 1974, the purchase price of $1.2 million was based roughly on five times PMS's pretax earnings of approximately $250,000. Ross, Transcr. at 1169, 1172; Schnitzer, Transcr. at 2149. Walter Ross (Ross) was a C.P.A. and senior vice president of finance at Century when it purchased PMS. Ross, Transcr. at 1166. In 1974, Ross became president of Century Corp. Id. at 1165. According to Ross, it was customary in the industry to base the purchase price of a service corporation such as PMS on a multiple of the firm's pretax income. Id. at 1172-1173.

Originally, PMS's property management business was almost all in Texas, principally Houston and Dallas. PMS typically managed office buildings and other commercial real estate owned by others under property management contracts on a month-to-month basis. As of the time of PMS's 1974 acquisition by Century, although Prudential was perhaps PMS's biggest customer, PMS managed a relatively small number of Prudential's commercial real properties. Shortly after Century acquired PMS, Schnitzer attempted to expand substantially the size of PMS's property management business, as PMS typically earned only a relatively modest profit margin on its individual property management contracts. Schnitzer felt that the only way to increase PMS's profits was having a large volume of such management contracts. To that end, in 1974, Schnitzer approached Ballard (who Schnitzer had previously dealt with in developing office buildings in Houston, Texas) and offered to have Century give Prudential a 50-percent stock interest in PMS. Although Prudential would not be paying anything for the 50-percent PMS stock interest, Schnitzer hoped that this would result in Prudential's awarding PMS a large number of additional property management contracts. Ballard informed his superiors at Prudential of Schnitzer's offer.

Initially, Prudential was interested in Schnitzer's offer. Schnitzer was invited to Prudential's Newark, New Jersey, corporate headquarters for further meetings and discussions with Prudential's management. Schnitzer met with Prudential's senior executives and corporate headquarters staff, including Prudential's chairman, and with Donald Knab (who headed Prudential's real estate department). Prudential was particularly interested in standardizing the reports it received on the operating results of its various commercial real properties around the country. However, Prudential ultimately declined Schnitzer's offer, because of the substantial number of pension plans whose real estate investment accounts Prudential managed. Prudential believed that having an ownership interest in PMS might be a potential conflict of interest and might present problems under the pension laws.

Although Prudential declined Schnitzer's offer, from 1974 through late 1977, PMS's property management business increased substantially, with Prudential being PMS's biggest customer. Pursuant to Schnitzer's discussions with Prudential's management and corporate headquarters staff in 1974, PMS standardized its reports on the Prudential commercial real properties that PMS managed. By 1977, PMS had expanded its property management operations to other cities around the country, including Atlanta, Georgia; Los Angeles and San Francisco, California; Newark, New Jersey; and Portland, Oregon.

Ballard introduced Schnitzer to Kanter at an Urban Land Institute meeting in Hawaii in the mid 1970s. Schnitzer, Transcr. at 2161-2164. In 1977, Schnitzer and Kanter discussed Century's possible sale of a 47.5-percent stock interest in PMS to IRA. Kanter indicated that, through Kanter's business contacts, Kanter could obtain additional property management business for PMS with other parties, including possibly with the Pritzker family.⁶²

In November 1977, Century sold a 47.5-percent stock interest in PMS to IRA for $150,000. The sale was made subject to Century's right to apply PMS's profits first to servicing the $1.1 million debt Century had incurred to purchase PMS in 1974. IRA IRA paid $50,000 at closing and issued a promissory note to PMS for the $100,000 balance. Exhs. 240, 241; Ross, Transcr. at 1200.

Schnitzer conferred with Ballard before agreeing to sell PMS's common stock to IRA. Schnitzer, Transcr. at 2166-2167. Schnitzer was content to sell PMS common stock to IRA at a bargain price in exchange for Kanter's promise to attempt to use his business contacts, including his relationship with the Pritzker family, to obtain more real estate management contracts for PMS. Schnitzer, Transcr. at 2167. Ross shared Schnitzer's view that PMS's common stock was sold to IRA at a bargain price in expectation that Kanter would use his many contacts to generate business for PMS. Schnitzer, Transcr. at 2170-2171; Ross, Transcr. at 1182, 1195, 1201.

Schnitzer and Ross were not relying on IRA, Schott, or Weisgal to generate additional business opportunities for PMS. Schnitzer and Ross were relying solely on Kanter to obtain additional business opportunities for PMS. Ross, Transcr. at 1195, 1201.

During the period 1976 to 1979, PMS obtained a growing number of management contracts from Prudential. Schnitzer, Transcr. at 2173. During the period 1976 to 1979, approximately 40 percent of PMS's revenue was derived from Prudential property management contracts. Exh. 977, at 10; Ross, Transcr. at 1188. By the end of 1979, PMS's revenues had tripled from 1974 when Century bought PMS for $1.2 million. Exh. 977, at 4; Exhs. 750, 964. PMS's gross income from 1976 to 1980 was:

 Year      Gross Income        Exhibit

In March 1979, Kanter brought to Schnitzer's attention a potentially large property management opportunity. Exhs. 259, 260. Nevertheless, in late March 1979, Schnitzer informed Kanter he was disappointed that Kanter had failed to produce the additional property management business for PMS that had been expected. Schnitzer decided Century should purchase IRA's 47.5- percent PMS stock interest. Exh. 262. Kanter suggested he might make a counteroffer to purchase Century's remaining shares in PMS. Exh. 263; Schnitzer, Transcr. at 2175. By letter dated July 17, 1979, Kanter proposed that IRA would purchase PMS's remaining shares for $3.1 million to be paid in installments over 10 years. Exh. 268. On August 1, 1979, Schnitzer and Kanter agreed that Century would purchase the PMS stock held by IRA for a price of $3.1 million, to be paid to IRA over 10 years with interest. Exh. 270.

In February 1989, Kanter wrote to Ross and inquired whether PMS would be interested in making an early, discounted final payment on the PMS stock repurchase agreement. Exh. 344. Kanter mentioned in his letter that IRA had assigned its contract rights under the IRA/PMS installment agreement and that any payment should be remitted to PSAC, Inc., which served as the depository for the assignee. Id. The record reflects that PMS accepted Kanter's proposal and remitted a final payment of $750,000 to PSAC in February 1989, and the payment was distributed to Carlco, TMT, and BWK, as discussed below. Exh. 345.

During the period 1979 to 1989, PMS made installment payments to IRA as set forth in the following table.

                   Table 7

Eulich's real estate development activities were primarily conducted through Vantage, Inc., a corporation that he owned. In addition, Eulich later became a majority shareholder in Motor Hotels Management, Inc. (MHM). During some of the years at issue, MHM, IRA, THC, and Gateway Hotel Management Corp. were partners in the Essex Partnership, which partnership is discussed more fully below.

In 1968, Eulich acquired Rodeway Inns, a company that owned a small chain of garden court motels. Over the years, Rodeway Inns increased the number of its motels. In acquiring many of Rodeway Inn's additional motels, Rodeway Inns and Eulich obtained financing from Prudential. From 1968 through about 1973, in securing this financing for Rodeway Inns, Eulich dealt with Ballard. In about 1974, Eulich and Prudential became dissatisfied with the performance of the hotel management company that was managing and operating some 16 Rodeway Inns motels that had been financed by Prudential.

Eulich decided to establish his own hotel management company, MHM, to operate the motels. Eulich arranged to have Robert James (James), who had substantial hotel management experience, serve as MHM's president and manage MHM's day-to-day operations. MHM was incorporated on January 1, 1975. MHM's three shareholders eventually included Eulich (who was the majority shareholder), James, and another longtime business associate, C. Huston Bell.

In persuading James to participate in the ownership and operation of MHM, it was agreed that MHM's hotel management business would be expanded. After MHM commenced its operations, although he generally was not involved in conducting MHM's day-to-day business operations, Eulich helped arrange financing for MHM and was actively engaged in marketing MHM's services to various outside parties in an effort to obtain additional hotel management business.

By the middle to late 1970s, MHM had acquired a good reputation for the hotel management services it offered. Prudential's real estate department staff generally were very satisfied with MHM's management of a number of hotel properties in which Prudential was involved. However, until about the early 1980's, MHM generally only managed smaller-size hotel properties, not large hotels. By about the early 1980s, MHM managed hotel properties nationwide in about 20 to 25 states, although to a more limited and lesser extent than it wished in the northeastern region of the country.

Previously, the real estate department staff in Prudential's regional offices negotiated hotel management contracts for Prudential's hotel properties on an ad hoc basis. By 1979, Ostroff had devised a model hotel management contract that Prudential's real estate department staff could use in negotiating such management contracts. Ostroff also worked on various hotel projects for Donald Knab, Ballard, and/or Lisle.

Ostroff first obtained a Hilton franchise for the Gateway. Although Hilton Hotels had been reluctant to grant Prudential a franchise, Ostroff obtained the franchise by pointing out to Hilton Hotels the other profitable business dealings it had with Prudential.

Ostroff next hired another hotel management company to take over the Gateway Hilton's management and operation. This management company was owned by Stanley Cox (Cox), an experienced hotel manager Ostroff had known during Ostroff's prior employment with Hilton Hotels. At some point, Cox assigned John Connolly (Connolly) to be the Gateway Hilton's onsite manager. Ostroff was extremely successful in turning around and substantially improving the Gateway Hilton's operating condition. Prudential corporate headquarters executives eventually were proud to have other Prudential executives and business visitors stay at the hotel. Prudential executives also made significant use of the hotel facilities for meetings and entertainment and were very pleased with the service that they and their guests received at the hotel.

Cox did not spend much of his own time actually running the Gateway Hilton. Over the years, Cox delegated more and more duties in the hotel's operation to Connolly. In 1981, Connolly was dissatisfied living in Newark and requested that Cox transfer him to another hotel that Cox managed in Atlanta. Connolly, Transcr. at 2623.⁶⁶ Although Cox granted Connolly's request, Ostroff wanted Connolly to stay at the Gateway Hilton, and he approached Cox with a proposal to transfer the Gateway Hilton management contract to Connolly and give Cox another management contract at a different hotel. Connolly, Transcr. at 2623-2624. Ostroff and his superiors at Prudential then decided to terminate Prudential's management contract with Cox and awarded the management contract to a hotel management company owned by Connolly.⁶⁷

Ostroff advised Connolly of Prudential's desire to have him manage the Gateway Hilton; however, Ostroff advised Connolly that he would have to establish a management company of his own because Prudential did not want to have its employees involved in operating the hotel and did not want any of the hotel's employees to be Prudential employees. All hotel employees would have to be employees of Connolly's hotel management company. However, establishing such a hotel management company presented a problem for Connolly, as Connolly's management company, among other things, would be required to employ a financial manager and an accounting staff to prepare and issue the financial reports on the Gateway Hilton's operations that Prudential expected. Moreover, its full-time employment of such personnel to perform these and other required services could well be uneconomical, as Connolly's company would be managing only one or at most two hotels. As discussed in detail below, Kanter and Eulich provided a solution to assist Connolly in managing the Gateway Hilton.

Kanter and Eulich were aware Connolly would need assistance organizing a hotel management company for the Gateway Hilton. Ballard was also aware of Connolly's needs, and he introduced Eulich to Connolly as someone who would assist Connolly with the support services he needed to properly manage the Gateway Hilton. Connolly, Transcr. at 2620-2621, 2631. Ballard believed Connolly also met with Kanter. Ballard, Transcr. at 184. As discussed below, Eulich (probably with Kanter's assistance) organized Gateway Hotel Management Co. (GHM) for Connolly.⁶⁸

In 1981, Eulich and Kanter organized a corporation called Essex Hotel Management Co. (Essex Corp.). Formby, Transcr. at 1502- 1503; Eulich, Transcr. at 1650; Clifford, Transcr. at 16691670. By letter dated October 16, 1981, Eulich informed Connolly that (1) GHM had been organized, (2) GHM was capitalized with $10,000, and (3) Connolly would be expected to pay $2,000 to Eulich from GHM's first distribution to cover his share (20 percent) of GHM's capitalization. Exh. 691.⁶⁹ It appears, however, the arrangement described above was not carried out because, on March 2, 1982, Connolly and Essex Corp. executed an option agreement (the GHM option agreement), which they purportedly had agreed to on September 18, 1981, which recited that Connolly owned 100 percent of GHM, Connolly was transferring to Essex Corp. an option to acquire 80 percent of GHM (80 shares at $100 per share) for 10 years and, in exchange for the option, Essex Corp. would pay Connolly $1,000 per year for 10 years. Exh. 817. The record also includes an $8,000 promissory note, dated December 15, 1981, from Connolly to Essex Corp. (the Connolly promissory note) requiring annual payments for 9 years and a final balloon payment in 1991. Exh. 4015.⁷⁰

In late 1981, GHM received from Prudential a management contract to operate the Gateway Hilton, and, in February 1982, GHM received a management contract to operate another Hilton-franchised hotel that Prudential owned at Midland, Texas (the Midland Hilton).⁷¹Exh. 695. Eulich believed Kanter assisted MHM and Essex Partnership in obtaining the management contract for the Gateway Hilton. Eulich, Transcr. at 1634. Eulich's testimony on this point is revealing. In short, Eulich considered the Gateway Hilton management contract to fall within MHM's portfolio of contracts (even though the contract technically was awarded to Connolly/GHM) because MHM's employees provided all the essential services required to manage the hotel.

                     Percentage

Essex Corp. and Essex Partnership were both in existence from January 1982 to December 1984. Formby, Transcr. at 15021503, 1516; Exh. 817. General ledgers were maintained for Essex Corp. Exh. 697; Formby, Transcr. at 1516. In some instances, transactions pertaining to Essex Partnership were posted to the general ledger of Essex Corp., rather than on the partnership's books. Formby, Transcr. at 1518.

On December 21, 1984, Essex Corp. assigned to Essex Partnership its rights under the GHM option agreement. Exh. 817, at 4. The record indicates Essex Corp. also transferred Connolly's promissory note to Essex Partnership. Exh. 4013. On October 26, 1987, Essex Partnership sent a check of $1,000 to Connolly. Id. The check was accompanied by a letter which explained that the check represented Essex Partnership's annual option payment to Connolly, and the letter included a request that Connolly remit to Essex Partnership his annual interest payment of $960. Id.

At trial, Connolly (1) did not know the identity of the partners of Essex Partnership, (2) believed he was offered a 5-percent partnership interest in Essex Partnership in exchange for his promise to refer to Eulich any hotel management contracts that GHM could not handle in the northeastern region of the country, and (3) did not understand that a portion of GHM's management fees was remitted to Essex Partnership. Connolly, Transcr. at 2631-2645.

Connolly could not recall any details about the GHM option agreement or whether he had received any payments pursuant to the option agreement. Connolly, Transcr. at 2661-2662; Exh. 4013. Connolly did not (1) know whether he had owned all of the shares of GHM, (2) recall speaking to Eulich about startup financing of $10,000 for GHM, or (3) recall whether the board of directors held meetings at GHM or the membership of the board. Connolly, Transcr. at 2650- 2653.

Essex Partnership had no office, equipment, or employees because employees of MHM performed many of the consulting services that GHM needed. John Formby, an accountant working for Lexington Investment Co., provided services to MHM and was given a power of attorney to act on behalf of Essex Partnership. Formby, Transcr. at 1499-1503; Exh. 4007.⁷³ Although the power of attorney apparently was prepared in December 1982, it was executed "as of" January 1, 1982. Exh. 4007. Formby performed accounting services for Essex Partnership, and he performed the financial and accounting services that GHM required in connection its hotel management contracts. Formby, Transcr. at 1500-1504, 1590-1591; Exh. 4009.

On January 1, 1982, MHM entered into a nearly identical "Representation and Marketing Agreement" with Essex Partnership (the MHM/Essex agreement) in connection with MHM's management contracts on the Allentown Hilton and the Madison Hotel. Exh. 349. Although Prudential had helped finance the latter two hotels' construction, Prudential apparently had no involvement in awarding the Allentown Hilton and Madison Hotel management contracts to MHM, as the two hotels were owned by third parties. MHM was required to pay to Essex Partnership 30 percent of its management fees from the operation of the Madison Hotel and 43 percent of the fees from the operation of the Allentown Hilton. Exh. 349, exh. A.

An MHM employee testified that, in managing GHM, Connolly was essentially a "one-man show". A number of MHM's management personnel were instructed by MHM's management to do whatever they could to help Connolly with GHM's operations. For instance, MHM employees helped perform the financial and accounting services that GHM required in connection with its Gateway and Midland hotel management contracts. In yet another instance, an MHM employee helped Connolly with union negotiations. Also, after Prudential awarded the Midland, Texas, hotel's management contract to GHM, MHM's employees helped Connolly find an onsite manager for that hotel. Although Connolly did give MHM some occasional help and advice, such as sales presentations to hotel owners, the volume of services that MHM employees furnished to GHM greatly exceeded the volume of services that MHM received from GHM and Connolly.⁷⁵

In late 1983, Prudential awarded to MHM the hotel management contract for Prudential's Hilton-franchised Twin Sixties Hotel at Dallas, Texas (the Twin Sixties Hotel). Shortly thereafter, MHM and Essex Partnership entered into a new "Representation and Marketing Agreement" pursuant to which Essex Partnership received a percentage of MHM's fees under the Twin Sixties Hotel management contract.⁷⁶Exh. 350, exh. A. The MHM/Essex agreement was modified to provide that MHM would pay 70 percent of its management fees from the Madison Hotel (an increase of 40 percent from the 30 percent required under the original agreement), 57 percent of its management fees from the Allentown Hilton (an increase of 14 percent from the 43 percent required under the original agreement), and 57 percent of its management fees from the newly acquired Twin Sixties Hotel management contract. Exh. 350, exh. A.

From 1982 through 1986, the specified percentage of fees Essex Partnership received under the various consulting and fee participation agreements it had with GHM and MHM varied and, at times, was adjusted.⁷⁷ In operating Essex Partnership, the partners agreed the fees GHM paid Essex Partnership generally would equal the fees MHM paid to the partnership. The partnership's specified percentage of fees under each consulting and fee participation agreement could easily be adjusted and modified, as each consulting and fee participation agreement was subject to cancellation on 30-to-90-days' notice. As a result, if a significant change occurred with respect to the compensation that GHM or MHM received under a particular hotel management contract, an offsetting change then could be effectuated in the other consulting and fee participation agreements GHM and MHM had with Essex Partnership.

As the total fees that MHM paid to Essex generally equaled the total fees that GHM (Connolly's hotel management company) paid to Essex, the total fees MHM paid to the partnership roughly approximated MHM's distributive share of partnership income as a .5- percent partner in Essex Partnership. However, as indicated previously, MHM was not paid directly for the substantial services its employees rendered to GHM. Rather, as a partner in Essex Partnership, MHM received 47.5 percent of the partnership's income. Although IRA and THC, as partners, also received a combined 47.5 percent of the income of Essex, IRA and THC, in contrast to MHM, provided no similar substantial services to GHM.

Eulich and MHM's top management essentially viewed involvement in Essex Partnership as a marketing and sales device, whereby MHM eventually might obtain more management contracts for large hotels. By having MHM participate in Essex Partnership, Eulich hoped to have Kanter help MHM obtain additional hotel management contracts.

Eulich was not familiar with IRA or THC and testified in pertinent part:

Connolly could not explain the benefits that GHM would receive under the GHM/Essex agreement; he did not expect anyone at Essex Partnership to perform liaison functions between himself and Prudential. Connolly, Transcr. at 2641-2644. Such a function or service would be unnecessary because Connolly believed that he had a "pretty solid relationship with all the people at Prudential." Id. at 2643.

Formby did not know what liaison functions Essex Partnership was expected to perform for GHM, and he believed that no such activities occurred. Formby, Transcr. at 1548-1549, 1555; Exhs. 348, 351.

James, the president of MHM, could not identify a specific person or entity who would have acted as a liaison between the owners and operators of the hotel properties in question. James, Transcr. at 1735-1737. James did not know that IRA and THC were partners in Essex Partnership until he was shown the partnership agreement at trial. James, Transcr. at 1734-1737.

There were no officers or employees at Essex Partnership who could have engaged in consulting or acted as liaisons. Formby, Transcr. at 1534-1535. Eulich had never seen the Essex Partnership agreement or the consulting and fee agreements between MHM or GHM and Essex Partnership. Eulich could not explain the meaning of the phrase in article II of the Essex Partnership agreement referring to Essex Partnership's role as "liaison intermediary between the owners and operators of hotel properties". Eulich, Transcr. at 1631-1634.

 Year       GHM           MHM       Exhibits

For the taxable years 1982 through 1989, Essex Partnership made distributions to IRA, THC, Connolly, and MHM as set forth in the following table.

                     Table 8

In 1986, MHM was sold by Eulich to an unrelated company called Aircoa. Aircoa continued to allow MHM to participate as a partner in Essex Partnership until about 1990.

Ultimately, the movie ventures in which the trusts invested proved unsuccessful and were not profitable. Additionally, the Internal Revenue Service later disallowed the deductions that Ballard claimed on his tax returns with respect to these movie investments and Ballard was required to pay additional taxes to the Internal Revenue Service. In July 1985, Mrs. Ballard borrowed about $160,000 from TMT to pay the income tax liability that she and Ballard owed.⁸⁰Exh. 94, at 10.

In 1987, IFI owed IRA in excess of $500,000 and did not have sufficient resources to repay IRA. Exh. 34, at 2. To "clean up" IFI's liability to IRA, Lawrence Freeman (IRA's president) and Linda Gallenberger (a TACI employee and an officer of convenience for IRA) had IFI (of whom IRA was now sole shareholder) transfer all of its assets to IRA in satisfaction of IFI's liability to IRA. Substantially all of the assets IFI transferred consisted of promissory notes that had been issued by various third parties, including the above promissory notes of Ballard's and Lisle's grantor trusts, as well as other notes that Ballard and Lisle had issued individually.⁸¹ On its books, IRA reduced IFI's liability to it by an amount equal to the full face amount of the notes IFI transferred.

As reflected by a memorandum dated July 17, 1987, Lawrence Freeman (IRA's president) and Linda Gallenberger agreed that the loans that IRA was holding that had been made to Ballard and Lisle, individually, and to their respective grantor trusts would be "forgiven", in view of the difficulty of collection.

In 1987, IRA sold for a stated price of $1 each to MAF, Inc. (MAF), a wholly owned subsidiary of Computer Placement Services, Inc., the promissory notes of Ballard's and Lisle's grantor trusts that IRA obtained from IFI. MAF had a relatively insubstantial amount of assets and operated out of the accounting firm offices of Albert Morrison (MAF's president). Freeman (who was then IRA's president) had asked Morrison (a certified public accountant and longtime friend of Kanter) to be MAF's president. Mr. Morrison received no salary for being MAF's president. As MAF's president, he approved the purchase by MAF of the promissory notes from the trusts as a favor to Kanter.⁸²

IRA subsequently also sold 100 percent of IFI's outstanding shares of stock to Linda Gallenberger for $1 in September 1988. Shortly thereafter, Ms. Gallenberger placed IFI into bankruptcy. On its 1987 tax return, IRA claimed losses with respect to its sale of the trust notes to MAF. IRA also claimed bad debt deductions with respect to the individual notes of Ballard and Lisle that it obtained from IFI. It further claimed a $65,000 worthless security deduction with respect to the IFI shares that were later sold to Ms. Gallenberger.

For substantially all of the period from about 1983 to 1989, KWJ Corp. (an IRA subsidiary) and later the KWJ Partnership (whose partners were IRA's subsidiaries BWK, Carlco, and TMT) paid monthly "consulting fees" of $1,000 each to Ballard's two daughters and to Lisle's son and daughter. After the Internal Revenue Service commenced examinations of many of Ballard's, Kanter's, and Lisle's respective returns for the years at issue, Kanter, in February 1990, sent letters to the children terminating KWJ Partnership's "consulting arrangement" with them.⁸³ In two of these termination letters, Kanter apprised the children that he had recently assumed IRA's presidency. He noted that their consulting arrangement had begun when Lawrence Freeman was IRA's president. In the letters, Kanter stated that the children had done nothing for a number of years, and he blamed Mr. Freeman for having KWJ Partnership continue to make monthly payments to them.⁸⁴

After becoming IRA's acting president in 1989, Kanter also discussed with Ballard and with Lisle the payment of their individual promissory notes that IRA held but had previously deducted as bad debts on IRA's 1987 return. Since at least 1987, Ballard had claimed that neither he nor his wife were liable on the promissory notes that they had previously executed. In late 1992, Ballard agreed to pay IRA $120,000 in settlement of his $196,000 debt to IRA on his promissory notes. Ballard also entered into an arrangement, at about this time, to repay the $160,000 loan his wife had received from TMT in July 1985.

Kanter reached a similar agreement with Lisle to discharge his debt to IRA. Originally, pursuant to certain payment negotiations Kanter and Lisle had in 1989, Lisle agreed to pay the debt in 2 years. He failed to do so, and he and Kanter discussed the matter again, until Lisle, at some point, agreed to pay the debt by the end of 1993. However, Lisle died before making any payment, and Kanter, acting on behalf of IRA, filed a claim against Lisle's estate.

Beginning in about 1990, Ballard was paid a salary by TMT, and Lisle was paid a salary by Carlco. Kanter, who was now IRA's president, agreed to have each of these IRA subsidiaries pay a salary to Ballard and Lisle. Ballard had requested that TMT pay him a salary. At various times from 1987 through 1989, some of Ballard's family trusts had also received loans from TMT in order to make certain real estate investments.

IV. Additional Findings of Fact: The Flow of Funds

Other than the limited discussion concerning loans to Ballard and Lisle and their family trusts set forth above, the STJ report did not include an analysis of the flow of funds that respondent offered as further proof that the payments from The Five constituted income earned by and properly taxable to Kanter, Ballard, and Lisle. The following additional findings of fact focus on the payments from The Five to IRA, THC, and other Kanter-related entities and how those funds were transferred to Kanter, Ballard, and Lisle, including a number of purported loans to Kanter, Ballard, Lisle, and their trusts. Because some of the payments from The Five to IRA were accumulated in IRA until 1983 and then transferred to Carlco, TMT, and BWK, we shall analyze separately the transfers of funds for the periods before 1984 and after 1983.

The Court's additional findings of fact are divided into eight sections. Section A provides both an overview of the payments made by The Five to IRA and its subsidiaries in connection with the various Prudential transactions from 1977 to 1989, and a breakdown of those payments for the periods 1977 to 1983 and 1984 to 1989. Sections B, C, and D focus on the distribution of those funds to Kanter, Ballard, Lisle, and their family members and trusts for the periods 1977 to 1983 and 1984 to 1989. Section E discusses payments made by The Five to THC and its subsidiaries during the years at issue. Sections F and G discuss the distribution of those funds to Kanter and Lisle.

Where necessary to add context, we restate some of the findings of fact set forth and properly supported by citations of the record earlier in this report. We do not repeat the citations of the record for these findings of fact.

                                Table 9

During the period 1983 to 1989, IRA maintained cash deposits as set forth in the following table:

               Table 10

The remainder of this section is divided into two subsections. Subsection 1 addresses all of the payments made by The Five during 1977 through 1983. These payments were paid to and accumulated by IRA and reported on IRA's consolidated returns. Subsection 2 addresses all of the payments made by The Five during 1984 through 1989. These payments were paid to IRA and/or other Kanter-related entities and distributed to Carlco, TMT, and BWK, at a time when the latter entities were no longer part of IRA's consolidated group for tax reporting purposes.

In 1984, in connection with Lisle's move to Travelers, Schaffel made a final payment of $213,750 to IRA and then began making payments to THC.

Frey continued to make payments to IRA's subsidiary Zeus during 1984 and 1985.

Schnitzer/PMS continued to make principal and interest payments to IRA with the exception of its final (accelerated) payment, which was remitted to PSAC and then distributed to Carlco, TMT, and BWK.

In December 1984, IRA transferred its interest in Essex Partnership to Carlco (45 percent), TMT (45 percent), and BWK (10 percent). See discussion infra pp. 170-171. Therefore, IRA no longer reported income from Essex Partnership on its consolidated returns. Although Essex Partnership continued to make payments to IRA, those payments were transferred to Carlco, TMT, and BWK, which reported the payments in accordance with their distributive shares of Essex Partnership items. Exhs. 61-66 (Carlco); Exhs. 84-89 (TMT); Exhs. 106-111 (BWK).

As Table 9 reflects, during the period 1984 to 1989, IRA received (1) $1,103,721 from Hyatt Corp. (through payments to KWJ Corp.),⁸⁶ $232,263 from Frey (through payments to Zeus), (3) $2,648,883 from Schnitzer/PMS (through installment payments of principal and interest), and (4) $623,867 from Eulich/Essex Partnership, for a total of $4,608,734.⁸⁷

After 1983, IRA reported as income only the payments from Frey to IRA's subsidiary Zeus and the payments from PMS. Exhs. 19-24 (Schedule 6252); Exh. 19, at 12; Exh. 20, at 16.

TMT listed the following bank and brokerage accounts as assets on its general ledgers for 1983 through 1989: A Wells Fargo account, a Citizen Bank account, a Goldman Sachs brokerage account, and a Kemper money market account. Exh. 9014; Exhs. 92-98.

During 1984 through 1989, moneys from TMT were deposited in an account maintained at the Wells Fargo Bank in San Francisco. The mailing address of this account was Ballard's home address. Mary Ballard, Transcr. at 2817. Ballard opened this account in the name of TMT, and he and his wife had signatory authority over it. Ballard, Transcr. at 223-224; Exhs. 614-617. The records for TMT were maintained at Ballard's home.

Beginning in 1984, Kanter purportedly directed that IRA's "free-cashflow" be distributed in the ratio of 45 percent each to Carlco and TMT and 10 percent to BWK. From 1984 through 1989, IRA generally transferred funds and other assets to Carlco, TMT, and BWK, in the respective 45/45/10 percent allocation ratio Kanter had directed.

During 1984, approximately $4.2 million was transferred from IRA to Carlco, TMT, and BWK in a 45/45/10 percent split by way of (1) transfers through the TACI Special E and the TACI Special Accounts and (2) distributions related to Essex Partnership and a partnership known as Sherwood Associates Partnership. Exhs. 2003, 2006, 2010.

(1) At a time unknown, but before March 25, 1983, IRA lent Zeus $51,000. Exh. 26, at 24, last item.

(2) On March 25, 1983, Zeus transferred $51,000 to IRA as a loan repayment. Exh. 26, at 24, last item.

(3) At a time unknown, but before October 21, 1983, IRA transferred $774,000 or a cash equivalent to THC in exchange for a receivable of $774,000 due from THC. Exh. 27, at 5 (AJE-25); Exh. 26, at 11 (11-22-83); Petitioners' Reply Brief at 491-492.

(4) On October 21, 1983, Zeus transferred $774,000 to IRA in exchange for the $774,000 THC receivable. Exh. 27, at 5 (AJE25); Exh. 26, at 11 (11-22-83).

(5) At a time unknown, but before December 5, 1983, IRA transferred $13,000 or a cash equivalent to THC in exchange for a receivable of $13,000 due from THC. Exh. 26, at 23.

(6) On December 5, 1983, Zeus transferred $13,000 to IRA in exchange for a $13,000 THC receivable. Exh. 26, at 23; Kuck, Transcr. at 3428-3443. Thus, at the end of 1983, Zeus retained $44,042 of the $882,042 paid by BJF, and Zeus held THC notes receivable totaling $787,000.

On January 12, 1984, Zeus transferred $5,028 to IRA in exchange for a $5,028 THC receivable. Exh. 9070, at 2. By the end of 1989, the THC receivables that Zeus received from IRA had not been repaid. Exh. 9070, at 2, 7 (1984 and 1989 general ledgers). There is no evidence in the record that Zeus ever accrued any interest or received any principal payment in connection with the THC receivables identified above.

In January of 1984, IRA recorded the receipt of a $44,413 payment received from Essex Partnership as payables of $19,986 due to each of Carlco and TMT and $4,441 due to BWK. Exh. 29, at 6. On January 30, 1984, IRA issued a check in the appropriate amount to each of the corporations and recorded the payments as payment of the payables owed to Carlco, TMT, and BWK. Exh. 29, at 1. Additional distributions from Essex Partnership to IRA during 1984 totaling $88,825 were also treated as distributed directly to Carlco, TMT, and BWK, by reducing the additions to capital attributable to IRA's contributions of cash made to the corporations during the year. Exh. 29, at 17.

IRA recorded the distribution of the Essex Partnership interest on its books as follows:

 1984 beginning value                                                 $45,283

Lisle professed to have no knowledge that Carlco held an interest in Essex Partnership. Exh. 2030, at 39.

In 1984, IRA transferred its 50-percent partnership interest in Sherwood to TMT (22.5 percent), Carlco (22.5 percent), and BWK (5 percent). Exh. 9014 (AJE 7 for 12/31/84); Exh. 69, at 16; Exh. 93, at 10; Exh. 114, at 6-7; Petitioners' Reply Brief at 524-525. When IRA distributed its Sherwood Partnership interest to Carlco, TMT, and BWK in 1984, IRA reported a gain of $51,744 on the distribution (apparently representing the difference between IRA's capital contributions of $325,000 and partnership losses totaling $376,742 that IRA reported for 1982 and 1983). Exh. 19, at 5 of 25.

In 1985, IRA reported a long-term capital loss of $46,925 attributable to the sale of a note receivable from Sherwood. Exh. 20, at 5. IRA reported that it acquired the note receivable in October 1984 and sold the note for $1,000 on December 1, 1985. Id. Neither IRA's general ledger nor its trial balance ledger for 1984 reflects the acquisition of a Sherwood promissory note.

      Item                 Carlco              TMT               BWK

At the end of 1984, IRA's records reflected that it

transferred capital contributions and paid-in capital to Carlco, TMT, and BWK as follows:

         Carlco               TMT                    BWK

             TMT                       Carlco                 BWK

In 1986, Sherwood changed its name to Forest Activity. Exhs. 9013-9015.

KWJ Partnership's total source of funds during the years 1984 through 1989 was $1,359,691, which included capital contributions of $6,100, Hyatt Corp. payments of $1,103,721, and IRA loans of $249,870. Petitioners' Reply Brief at 538.

IRA made loans to KWJ Partnership totaling $30,000, $45,000, $38,000, $48,000, $20,000, and $68,000 during 1984 to 1989, respectively. See app. 5 to this report. As of July 30, 1990 (the date KWJ Partnership filed its tax return for 1989), these loans had not been repaid. Exh. 957. These loans provided a large portion of the funds KWJ Partnership used to make consulting payments to Ballard's and Lisle's children as discussed in additional findings of fact infra pp. 192-194.

During 1984 to 1989, Carlco's, TMT's, and BWK's distributive shares of the Hyatt Corp. payments to KWJ Corp. were $496,539, $496,539, and $110,342, respectively. Exhs. 61-66, 84-89, 106111; Petitioners' Reply Brief at 538.

One additional matter regarding the Hyatt Corp. payments deserves mention. On August 2, 1989, IRA issued checks of $22,619 each to Ballard and Lisle. After the checks were issued to Ballard and Lisle, IRA records reflected a transfer of $45,237 to KWJ Partnership on August 8, 1989. Also on August 8 and 15, 1989, IRA ledger entries reflected that the checks issued to Lisle and Ballard, respectively, were void. Exh. 36, at 9. Despite the fact that IRA's ledger entries showed that these checks were void, Lisle's 1989 return reflected that he actually cashed the check. Lisle reported the $22,619 on his individual tax return as income from the "KJW [sic] Company." Exh. 421, Statement 1.

 Year       Carlco      TMT       BWK

 Carlco         TMT            BWK

TACI's June 30, 1984, trial balance ledger reflected that loans had been made to Ballard, Seabright Trust,⁹⁴ and Seabright Corp. as follows:

 Ballard   Seabright Trust     Seabright Corp.

On August 7, 1984, money was transferred from the TACI Special E Account to the TACI Special Account designated for Ballard, Seabright Trust, and Seabright Corp. in the following amounts:

 Ballard   Seabright Trust     Seabright Corp.

From 1984 through 1989, Seabright Trust and Seabright Corp. received additional loans from TMT. The balances on these loans at the end of each year were as follows:

 Year      Seabright Trust     Seabright Corp.     Exhibit

From 1984 through 1989, TMT made loans totaling $303,943 to Claude Ballard and Mary Ballard. The balances due on these loans at the end of each year were as follows:

 Year      Claude Ballard      Mary Ballard   Exhibit

On January 20, 1987, Ballard executed a promissory note which provided that (1) Ballard agreed to pay to TMT, on demand, the principal sum of $100,000, and (2) the note would not bear interest, but TMT was entitled to receive 90 percent of the "dividends" paid to Ballard by Fairfield. Exh. 9018. At the same time, Ballard and Mary Ballard, acting as TMT's president, executed an agreement which stated that (1) Ballard was executing a promissory note to TMT and was pledging 1,000 shares of Fairfield common stock as security for the note, and (2) TMT, as part of the transaction, agreed to advance in the future "any deficits incurred by * * * Ballard in the operations of Fairfield * * * and is to receive 90% of the dividends paid by Fairfield". Id. Ballard and Mary Ballard (acting in her individual capacity) also executed an assignment which stated that "for the purpose of securing the payment of all indebtedness now owing, or which may at any time hereafter be owing" by Ballard to TMT, the Ballards assigned to TMT 1,000 shares of Fairfield common stock. Id.

In 1987, TMT apparently paid an additional $20,344 to Fairfield, and this amount was treated as an additional loan to Ballard. Exh. 96, at 2.

The Ballards reported Fairfield items of income and loss on their 1987, 1988, and 1989 tax returns. Exhs. 391-393.

When Gallenberger was questioned about the accounting entries for the Fairfield transaction, she could not recall the details and suggested Ballard should be questioned on the matter.⁹⁶ Ballard believed that (1) he owed TMT approximately $200,000 on the Fairfield transaction, (2) TMT continued to receive "interest" on the deal, (3) he owned two-sevenths of Fairfield, (4) the initial Fairfield investment was $1,350,000 and the investment had increased in value to approximately $2,350,000, and (5) the Fairfield transaction was a good deal for TMT and a bad deal for Ballard. Ballard, Transcr. at 249-250, 286-288. There is no evidence in the record that TMT ever received any payments (interest, dividends, or otherwise) attributable to Ballard's promissory note described above.

The record is unclear as to whether TMT ever owned shares in Fairfield that it could transfer to Ballard. Ballard asserted in Petitioners' Reply Brief at 625-626 that because Fairfield was an S corporation, TMT could not own stock in the company. LaRue, Transcr. at 3587. Nevertheless, TMT's adjusting journal entries identified the property that was transferred to Ballard as "Fairfield Planting Company" (Exh. 9014, at 34), while TMT's general ledger identified the asset that was transferred to Ballard as land (not shares of stock). Exh. 96, at 4.⁹⁷

Gallenberger could not explain the Fairfield transaction at all, and Ballard's testimony regarding the matter was inconsistent with TMT's general ledger entries. Ballard's explanation suggests that (1) Ballard received a TMT asset worth considerably more than the amount recorded on TMT's books, and (2) Ballard issued a promissory note to TMT that he never intended to repay.

During the period 1987 to 1989, Ballard reported as income on his tax returns substantial director's fees from Seabright Corp. Exhs. 391-393. On October 14, 1988, Ballard submitted a disclosure statement to Goldman Sachs which stated: "I am personally involved in substantial farming operations individually as well as in partnership form. Family trusts control two corporations which are similarly involved." Exh. 9072. At trial, Ballard testified that the family trusts referred to in his disclosure statement to Goldman Sachs were the Bea Ritch Trusts, which purportedly owned IRA (and ostensibly TMT), and the two corporations he was referring to were TMT and Fairfield. Ballard, Transcr. at 235-236.

Ballard's testimony on this point is inconsistent with his earlier testimony and is not credible. In particular, Ballard testified that, as of 1987, he owned Fairfield -- there is no evidence that a trust owned Fairfield. The family trusts and two corporations mentioned in Ballard's disclosure statement were the Orient Trust (which owned TMT) and Mary Family Trust (which owned Seabright Corp.).

On June 13, 1989, Goldman Sachs issued a memorandum regarding "Outside Business Activities and Private Investment" reminding Goldman Sachs personnel of NYSE and NASD rules that required each general partner and employee to obtain prior written approval with respect to outside business activities and private investments. Exh. 5938, at 11. In response to this reminder, on August 2, 1989, Ballard submitted to the Goldman Sachs compliance department a Request for Approval of Outside Business Activities and/or Private Investments Form. Exh. 1029. In response to a direction to provide a "Complete description of the investment or business affiliation. What is it and who else is involved in it as principals? Does it involve a public or private company?", Ballard answered, in part: "Farmland -- Have been buying and selling for years." Id. Ballard did not identify IRA or TMT as principals and/or private companies with regard to these activities.

When Ballard became the director of an organization called ICM Property Investors, Ballard submitted to Goldman Sachs an "Outside Business Activities Information and Request Form". Exh. 1031. Ballard's involvement with this organization was through a "close friend" who controlled the property. Id. In contrast, Ballard never submitted such a form to Goldman Sachs with respect to TMT, which he purportedly was managing for IRA at Kanter's request.

During 1987, 1988, and 1989, TMT had total assets of $2,773,138, $3,240,582, and $4,855,921, respectively. Exhs. 9014, 96- 98. TMT's cash holdings during 1987, 1988, and 1989 totaled $232,635, $243,386 and $492,817, respectively. Id. TMT's notes receivable during 1987, 1988, and 1989 totaled $433,618, $472,618, and $482,618, respectively. Id. During 1987, 1988, and 1989, TMT's investments in bonds (including municipal bonds) totaled $1,102,948, $1,288,862, and $1,477,690, respectively. Id.

On April 12, 1985, Lisle wrote a check of $3,000 against funds in Carlco's account at Connecticut National Bank to repay a loan from TACI. Exh. 612 (April bank statement, check No. 1011, Bates 000318). The memo section of this check stated: "Payment on Loan". Id. Lisle used Carlco's funds to repay the loan TACI made to RWL Cinema Trust I. This payment did not generate a loan from Carlco to RWL Cinema Trust, or a loan from IRA to the RWL Cinema Trust, or a loan from Carlco to Lisle, Exh. 70; Exh. 32. No loan arose from this transaction because the money in the Connecticut National Bank account belonged to Lisle, and he used that money to pay a personal debt.

 Year      Burton Kanter  Joshua Kanter

During the period 1987 to 1989, BWK lent a total of $236,000 to PSAC to support its operations. Gallenberger, Transcr. at 1985-1986; Petitioners' Reply Brief at 636. There is no evidence that any principal or interest was paid to BWK on these loans. Id.

On March 2, 1982, IRA paid Lisle $1,157.84. Exh. 606 (Bates No. 0003209).

In 1982, KWJ Corp. began paying Thomas Lisle, Amy Albrecht, and Melinda Ballard $1,000 each per month by checks drawn on the TACI Special E Account. Exh. 17, at 16, l. 23; Kanter, Transcr. at 3644- 3645; Exh. 9100. These payments continued during 1983. Exh. 18, at 20; Exh. 935; Melinda Ballard, Transcr. at 3723; Thomas Lisle, Transcr. at 930-931.

Beginning in 1984, after KWJ Corp. was liquidated, Thomas Lisle, Amy Albrecht, and Melinda Ballard continued to receive $1,000 each per month from the newly formed KWJ Partnership. Exh. 176 (multiple pages 2-20). In November 1984, Karen Ballard Hart also began receiving $1,000 per month from KWJ Partnership. Id. at 18. These payments generally continued until 1989. Exhs. 476, 9009.

The payments to the Ballard and Lisle children from KWJ Corp. and KWJ Partnership totaled $323,000, as summarized below:

 Year      KWJ Partnership     KWJ Corp.

In early February 1990, after the Internal Revenue Service began examining Ballard's, Kanter's, and Lisle's tax returns for the years at issue, Kanter sent letters to Ballard's and Lisle's children terminating their "consulting arrangement". Exhs. 476, 9009. In his letter to Amy Albrecht, Kanter stated that "fundamentally no services appear to have been performed for a number of years". Exh. 476. Kanter explained why Albrecht continued to receive the monthly payments as follows:

                Type of      Trust

                Type of     Trust

IRA lent substantial sums to IFI, and, as of January 1987, IFI owed $507,708 to IRA. Exh. 34, at 2. As discussed below, Ballard's and Lisle's grantor trusts borrowed substantial sums from IFI to invest in IFI tax shelters.

Before 1983, IRA transferred $1,189,900 to HELO purportedly as loans. Exh. 26, at 23.

IRA transferred receivables of $160,400 and $500 due from Ballard, individually, to IFI in exchange for receivables due from IFI in like amounts. Exh. 9005, at 4, ll. 24-26 (AJE 21); Exh. 26, at 28.

Loans to Ballard, Lisle, and their grantor trusts were either sold for $1 or written off as bad debts as described in the following steps.

      IFI Receivables

      IFI Receivables

           IFI Receivables

Simultaneously with the transfer of IFI's receivables to IRA (listed above), IRA sold 10 of the receivables (with a face value of approximately $800,000) to MAF, Inc., for $1 per receivable or a total of $10. Exh. 5911, at 6 (AJE 9, ll. 17-29); Exh. 5911, at 9 (AJE 23, ll. 26-28); Exh. 34. The 10 receivables in question were those of Safari Trust, CMB Cinema Trust, CMB Cinema Trust II, RWL Cinema Trust, RWL Cinema Trust II, HGA Cinema Trust, Elk Investment Partnership, Inter Alia, Hargen, and HELO (the Basking Ridge Trust and Summit Trust notes). Exh. 5911, at 6 (AJE 9); Petitioners' Reply Brief at 574.

By the end of 1987, IRA still held a receivable of $485,825 due from HELO and a receivable of $345,869 due from Cedilla Investment Co. Exh. 9189. On December 22, 1987, IRA sold to MAF for $1 the HELO and Cedilla Investment Co. receivables totaling $831,692. Exh. 34, at 13, first entry; Exh. 5911 (AJE 32, last page).

On December 22, 1987, IRA also sold its interest in 1984 Development Partnership to MAF for a promissory note for $1,000. Exh. 9189. IRA claimed a long-term capital loss of $22,862 attributable to this transaction on its 1987 tax return. Exh. 22, Schedule D.

Morrison (through MAF) entered into the transactions with IRA described above merely as an accommodation to Kanter. Morrison, Transcr. at 4530. After purchasing the notes from IRA, MAF did no other business. Morrison, Transcr. at 4517.

By the end of 1987, neither Ballard nor Lisle owed any portion of their original loans totaling $196,648 and $28,284, respectively, to either IRA or IFI. CMB Cinema Ventures no longer owed $250 to either IRA or IFI. Likewise, Ballard's and Lisle's grantor trusts' original loans totaling approximately $357,000 were no longer owed to IRA or IFI. Exh. 34.

In 1987, Ballard reported $2,400,252 of total income on his Federal income tax return, including $212,309 of interest and dividend income and $1,018,367 of capital gain income. Exh. 391. In 1987, Ballard had the resources to repay either IRA or IFI the loans he had received individually and through his trusts. Although IRA wrote off Ballard's receivable as a bad debt, Ballard did not report the discharge of this indebtedness as income on his 1987 tax return or on subsequent returns. Exhs. 391-393.

In 1987, Lisle reported $746,923 of total income on his Federal income tax return, including $255,707 of interest and dividend income. Exh. 418. In 1987, Lisle had the resources to repay either IRA or IFI the loans he had received individually and through his trusts. Although IRA wrote off Lisle's receivable as a bad debt, Lisle did not report the discharge of this indebtedness as income on his 1987 tax return or on subsequent returns. Exhs. 418-421.

Neither Ballard, Lisle, nor their grantor trusts paid any interest to IFI or IRA on the loans to them which were subsequently written off as bad debts or sold for $1. Exhs. 383393, Exhs. 417-421; Exhs. 954, 955 (IFI returns). The record does not include loan documents or notes evidencing the loans to Ballard, Lisle, and their grantor trusts.

At the end of 1987, IRA sold its IFI stock to Gallenberger for $1. Exh. 5912, at 7 (AJE 6). In addition to receiving the IFI stock, Gallenberger was given $3,000 identified as accounting fees. Exh. 9020; Exh. 35, at 12. IRA claimed a long-term capital loss of $65,000 attributable to this transaction on its 1987 tax return. Exh. 22, Schedule D.

In March 1989, approximately 2 years after IFI transferred receivables of $1,120,889 to IRA, IFI filed for bankruptcy. Exh. 627. At the time of the bankruptcy filing, Gallenberger was IFI's vice president, and she owned 100 percent of its stock. At the time of IFI's bankruptcy, IFI owed debts to the following creditors:

 Creditor                      Reason              Amount of Claims

                               Table 11

                               Table 12

During 1984 to 1986, Schaffel made payments to THC totaling $2,763,500 representing Kanter's share of fees that Schaffel earned arranging Travelers financing for Walters's projects.

During 1981 through 1987, Frey made payments to THC totaling $500,770. These payments included shares of development and management fees pursuant to Kanter's and Frey's oral agreement, as well as shares of profits from Prudential projects and development fees from projects not involving Prudential properties pursuant to the Frey/THC agreement. These payments served to compensate Kanter for using his influence to obtain Prudential projects for Frey and for using his influence to bring wealthy investors to Frey's projects not involving Prudential properties.

During 1982 through 1989, Essex Partnership made payments to THC totaling $645,009 representing cash distributions on THC's partnership interest. These payments served to compensate Kanter for obtaining hotel management contracts for MHM.

During 1983, THC transferred $2,335,298 from its account to TACI's accounts. Exhs. 148, 149, 174; Petitioners' Reply Brief at 646.¹⁰⁰ These transfers were identified in THC's general ledgers as investments, loans, or repayments of loans. Petitioners' Reply Brief at 647. During 1983, $1,339,843 was transferred from TACI's accounts back to THC identified as returns on THC's investments, loans from TACI, and repayments of earlier loans from THC to TACI. Exh. 5406, Petitioners' Reply Brief at 647-648.¹⁰¹ At the end of 1983, THC had $392,539 in TACI's accounts. Petitioners' Reply Brief at 648-649.

During 1984, THC transferred $1,194,000 from its bank account to TACI's accounts. Exhs. 149, 150; Petitioners' Reply Brief at 649.¹⁰² These transfers were identified in THC's general ledgers as investments, loans, or repayments of loans. Petitioners' Reply Brief at 649-650. During 1984, $756,300 was transferred from TACI's accounts to THC's account, and in most instances these transfers were identified as returns on THC's investments. Exh. 5406; Petitioners' Reply Brief at 650-651.¹⁰³ By the end of 1984, the net increase in THC's funds deposited with TACI was $434,700, for a total of approximately $827,000. Petitioners' Reply Brief at 651-652.

During 1983 and 1984, a total of $1,525,458 was transferred from the TACI Special Account to Kanter's personal bank account identified as loans and retainer fees, as follows:

 Transfer               Amount      Appendix

Kanter's personal bank account records for the period December 1982 through December 1984 show that Kanter made withdrawals for his personal benefit and the benefit of his family. Exh. 5408 (items 1-730); Petitioners' Reply Brief at 652-653.

As of October 31, 1987, Kanter had outstanding loans from TACI totaling $1,346,641. Exh. 9113; Petitioners' Reply Brief at 656-657.

As discussed, supra pp. 64-65, TACI filed for bankruptcy in February 1988. Lawrence Korrub, TACI's bankruptcy attorney, never received the records that TACI maintained for Kanter and his related entities because Gallenberger sent TACI's books and records, including the bank statements and canceled checks related to the TACI Special E and TACI Special Accounts, to Kanter. Gallenberger, Transcr. at 1970-1973. There is no evidence of notes for any of the funds transferred from the TACI accounts to Kanter's personal bank account, nor is there any evidence that Kanter repaid the approximately $1.3 million that he owed TACI at the time of its bankruptcy. Considering all of the circumstances, we infer that Kanter directed the transfer of THC'S funds into TACI's accounts as well as the subsequent transfers from TACI's accounts into his personal bank account. Kanter did not intend to return these funds to either TACI or THC because these funds belonged to Kanter.

Four Ponds Partnership and One River Partnership (1) reported net losses for 1981 to 1984 and 1987 to 1989 totaling $1,067,131, and (2) made cash distributions to its partners in 1981 to 1984 and 1987 to 1989 totaling $731,080. Respondent's Opening Brief at 349-350, par. 1016; Petitioners' Reply Brief at 663-664; Exhs. 125-134 (Kanter); Exhs. 417-421 (Lisle); Exhs. 9090-9094 (FPC Subventure Partnership tax returns and Schedules K-1 for Four Ponds Partnership and One River Partnership).¹⁰⁴ Approximately 7 percent of Four Ponds Partnership's and One River Partnership's losses, described above, flowed through to Lisle from FPC Subventure Partnership. Exhs. 417-421.

The cash distributions made to FPC Subventure Partnership from Four Ponds and One River were deposited into the TACI Special E Account. Exh. 205; Exh. 176, at 10, 15; Exh. 174, at 126-127. Shortly after the money from Four Ponds and One River was deposited into the TACI Special E Account, 90 percent of that money was distributed directly to Lisle. Exh. 176, at 10, 15; Exhs. 914-917; Exh. 5415. During the period 1981 to 1989, Lisle received a total of $682,520 in cash distributions from FPC Subventure Partnership. Exhs. 9090-9094, 417-421. A Schedule K1 that FPC Subventure Partnership issued to Lisle for 1989 showed that his capital account at the end of 1989 was negative $2,745,636. Exh. 9092.

A Schedule K-1 that Four Ponds issued to Kanter for 1989 showed that Kanter/FPC Subventure Partnership's capital account at the end of 1989 was a negative $1,288,755. Exh. 215. A Schedule K-1 that One River Partnership issued to Kanter for 1989 showed that Kanter/FPC Subventure Partnership's capital account at the end of 1989 was negative $1,767,981. Exh. 9094.

FPC Subventure Partnership was a conduit that Kanter used to transfer to Lisle a share of the payments that Schaffel made to THC on Travelers transactions from 1984 to 1986.

V. Additional Findings of Fact Regarding the Examination Process and Summons Enforcement Proceedings

As previously discussed, the Kanters paid a small amount of Federal income tax for 1978. The Kanters filed tax returns for 1979 to 1989 reporting no tax liability.

It was during this period that (1) Kanter wrote to Ballard's and Lisle's children and explained that he was terminating their purported consulting agreements, (2) Ballard and Lisle began to be paid for managing Carlco and TMT, and (3) Kanter began to negotiate with Ballard and Lisle regarding the loans IRA wrote off as bad debts in 1987.

During the examination process, Kanter, Ballard, Lisle, and their associates failed to produce information the IRS requested orally and/or through written information document requests. Lunk, Transcr. at 1042-1050, 1059. Kanter produced only documents related to Schedule A deductions under examination. Lunk, Transcr. at 1056-1057; Dion, Transcr. at 832-835, 837-838. Kanter, Ballard, and Lisle failed to produce records sought by the IRS concerning their grantor trusts and other related entities. Lunk, Transcr. at 1057-1058.

The summons to PSAC dated October 1, 1990, requested, in part, documents pertaining to PSAC, IRA and its subsidiaries, THC and its subsidiaries, BWK, and the Bea Ritch Trusts. The summons requested production of the cash receipts journals, cash disbursement journals, general ledgers, subsidiary ledgers, and ledgers for all bank accounts including the TACI Special E Account. Exh. 9046. The summons also requested production of documents pertaining to any corporations or partnerships in which Kanter, his family, and/or his family trusts were shareholders. Id.

Gallenberger testified at the May 19, 1994, hearing that documents relating to TACI were never returned to her from TACI's bankruptcy counsel.¹⁰⁶ She testified that many records of PSAC, Administrative Enterprises, Zion, and the Kanters no longer existed. Gallenberger testified that she disposed of some documents after receipt of the IRS summons. United States v. Administration Co., supra; Exh. 9047 -- Mem. Op. and Ord. of May 20, 1994.

The District Court concluded that none of the summoned documents were produced and the Kanters and the four Kanterrelated entities acted in bad faith in failing to comply with and blocking enforcement of the summonses. The District Court ordered Gallenberger, on behalf of PSAC, to appear before the IRS by May 24, 1994, and produce the records sought by the summonses. United States v. Administration Co., supra; Exh. 9047 -- Mem. Op. and Ord. of May 20, 1994.

Although Gallenberger appeared before the IRS and testified and produced some documents on May 24, 1994, she did not search all of the records in her possession but instead looked in every fifth, sixth, or seventh file. On June 10, 1994, the Government filed with the District Court a motion to hold Gallenberger in contempt. On June 22, 1994, the District Court held a further hearing. The District Court noted that PSAC operated much like a registered agent and a document repository primarily for the benefit of Kanter-related entities, and most of PSAC's over 2000 files related to Kanter. United States v. Administration Co., 74 AFTR 2d 94-5256, 94-2 USTC par. 50,480 (N.D. Ill. 1994), affd. 46 F.3d 670 (7th Cir. 1995); Exh. 9047 -- Mem. Op. and Ord. of June 22, 1994, at 3-4.

During the June 22, 1994, hearing, Gallenberger explained to the court that she produced very few documents because very few of PSAC's documents related to transactions between the subject entities and PSAC. The District Court rejected Gallenberger's narrow interpretation of the summons and concluded the summons fairly encompassed all the documents in the possession of PSAC in any manner related to the Kanters or Kanter-related entities. The District Court also concluded that Gallenberger's sampling of documents did not discharge her duty to make all reasonable efforts to comply with the court's order. Finding a "glaring deficiency in her compliance", the District Court, by order dated June 22, 1994, held Gallenberger in contempt of court and granted her until July 1, 1994, to purge herself of contempt by fully complying with the court's order. United States v. Administration Co., 74 AFTR 2d 94-5256, at 94-5258, 94-2 USTC par. 50,480, at 85,772; Exh. 9047 -- Mem. Op. and Ord. of June 22, 1994, at 4-5.

Gallenberger appealed the District Court's order of June 22, 1994, holding her in civil contempt, to the Court of Appeals for the Seventh Circuit. The Court of Appeals affirmed the District Court's order. See United States v. Administrative Enters., 46 F.3d 670 (7th Cir. 1995).

At the start of the trial in these cases, respondent issued subpoenas to various Kanter-related entities requesting production of documents. Exh. 9045. In addition to the books and records of IRA, THC, Carlco, TMT, and BWK, respondent requested production of documents relevant to determining the ownership of these entities, including stock ledgers and records of stockholders. At the start of the trial, Kanter's counsel informed the Court that no documents would be produced because the subpoenas were served on Gallenberger and she was not the custodian of records for IRA, THC, Carlco, TMT, and BWK. Dick, Transcr. at 26-27. Kanter's counsel informed the Court that Kanter was the custodian of the records in question. Dick, Transcr. at 26-27. Respondent then served Kanter with subpoenas for the documents in question. Transcr. at 28.

Petitioners produced complete THC trial balances only for 1980 and 1981. Exhs. 5850, 5851. Respondent possessed from prior audits (1) partial general ledgers of THC for 1983, 1984, and 1985, Exhs. 148-150, and (2) partial trial balances of THC for 1983 and 1984, Exhs. 161-162; Gallenberger, Transcr. at 25102511. There are no complete receipts and disbursement journals, general ledgers, or trial balances for THC for 1980, 1981, 1982, 1985 (partial), 1986, 1987, 1988, and 1989. Accordingly, payments made by Schaffel, Frey, and Eulich/Essex Partnership to THC are not traceable through THC's books and records.

Gallenberger had in her possession the records of THC for 1986, 1987, and 1988 and at some point turned those records over to Kanter. Gallenberger, Transcr. at 2510, 2713. After respondent requested production of the THC records, Kanter never asked Gallenberger for them. Gallenberger, Transcr. at 2517. Kanter possessed THC's records but failed to produce them.

Kanter also possessed the books and records of IRA, TMT, Carlco, and BWK. When respondent requested production of the records of IRA, TMT, Carlco, and BWK, they had to be retrieved from Kanter. Gallenberger, Transcr. at 2714-2715.

Gallenberger and Kanter possessed records relevant to determining the ownership of IRA and THC. At the summons enforcement hearing, Gallenberger testified that she had the information available to decide, herself, the ownership of any of PSAC's clients. United States v. Administration Co., 74 AFTR 2d 94-5256, 94-2 USTC par. 50,480 (N.D. Ill. 1994); Exh. 9047 -- Mem. Op. and Ord. dated June 22, 1994, at 6.

Neither Gallenberger nor Kanter produced stock ledgers for IRA, THC, Carlco, TMT, or BWK. With respect to Carlco, TMT, and BWK, the only documents Kanter produced concerning ownership were copies of initial stock certificates showing that the Kanter, Ballard, and Lisle family trusts owned the preferred stock of BWK, TMT, and Carlco, respectively, and a copy of an initial stock certificate showing that IRA owned the common stock of these entities. No documentary evidence was introduced to show whether ownership changed from the initial issuance dates of the stock certificates that Kanter produced.

When the trustees of Kanter's family trusts, Baskes and Weisgal, were asked to produce documents, they, likewise, failed to do so, on the ground that they did not have the requested information in their possession. Weisgal, Transcr. at 469-470; Baskes, Transcr. at 574-578.

PSAC had a "policy" of refusing to turn documents over to anyone other than their owner. Exh. 429; Exh. 9021, at 4; Gallenberger, Transcr. at 2733-2734.

Respondent first contends that IRA, THC, Carlco, TMT, BWK, and other Kanter-related entities were shams and/or nothing more than the alter egos of Kanter, Ballard, and Lisle. In the alternative, respondent maintains that, by directing The Five to remit their payments to IRA and THC, and distributing those payments to Carlco, TMT, BWK, and others, Kanter, Ballard, and Lisle violated the assignment of income doctrine. Finally, respondent asserts the Court should reallocate the income in dispute to Kanter, Ballard, and Lisle pursuant to section 482.¹⁰⁷

Petitioners assert the payments from The Five were earned and properly reported as taxable income by IRA, THC, and other Kanter-related entities. Petitioners also dispute respondent's assertion that the payments from The Five represented kickback payments to Kanter, Ballard, and Lisle. Petitioners deny that any kickback scheme existed.

The Commissioner's deficiency determinations normally are presumed to be correct, and the taxpayer bears the burden of proof. Welch v. Helvering, 290 U.S. 111, 115 (1933). On the other hand, the Commissioner bears the burden of proof with regard to (1) any increase in the deficiency raised in the pleadings, and (2) any case involving the issue of fraud with intent to evade tax. Rule 142(a) and (b); see sec. 7454(a).

There is no dispute the payments from The Five constituted taxable income to the persons or entities that earned the income. Thus, the first issue in these cases is a simple one: Did Kanter, Ballard, and Lisle earn the payments from The Five?

When payments are remitted to a corporation, as is the case here, a question may arise whether the corporate entity earned the income. Generally, a corporate entity will be recognized for tax purposes. In Moline Props. Inc. v. Commissioner, 319 U.S. 436, 438-439 (1943), the Supreme Court established the following test for determining whether a corporation will be recognized as a separate taxable entity:

Even if a corporation is not a sham because it is engaged in some legitimate business activity, payments to a corporation may nevertheless be reallocated to another person or entity under the assignment of income principles mentioned above. In a corporate context, particularly in cases involving closely held personal service corporations, the determination of the true earner of income can be difficult. In Johnson v. Commissioner, 78 T.C. 882, 890-891 (1982), affd. without published opinion 734 F.2d 20 (9th Cir. 1984), a professional athlete who had conveyed the exclusive rights to his personal services to a corporation contended that the corporation, rather than he, was taxable on amounts paid directly to it by his employer. Recognizing that a corporation can act only through its employees and agents, this Court set forth two requirements that must be met before the corporation, rather than the service-performing individual, can be considered to control the earning of the income. These requirements are: (1) The corporation must have had the right to direct or control the individual's activities in some meaningful manner, and (2) there must exist between the corporation and the person or entity using the services a contract or similar indicium recognizing the corporation's controlling position. Id. at 890-891.

The U.S. Courts of Appeals for the Seventh Circuit and the Federal Circuit apply a more flexible facts and circumstances approach. Schuster v. Commissioner, 800 F.2d 672, 677-678 (7th Cir. 1986), affg. 84 T.C. 764 (1985); Fogarty v. United States, 780 F.2d 1005, 1012 (Fed. Cir. 1986).

In United States v. Newell, 239 F.3d 917 (7th Cir. 2001), the Court of Appeals for the Seventh Circuit addressed both the assignment of income doctrine and concepts of alter ego in a factual setting analogous to the facts presented in these cases. In Newell, the taxpayer was president and a 50-percent shareholder of LPM, Inc. (Inc.), a commodity trader. Pursuant to a contract, Inc. earned a fee of $1.3 million from a client during 1993, and the taxpayer directed the client to pay the fee to LPM, Ltd. (Ltd.), a Bermuda corporation. Neither the taxpayer, Newell, nor Inc. reported the payment to Ltd. as income. The taxpayer subsequently was convicted of willfully filing false Federal income tax returns for 1994 for both himself and Inc.

On appeal, that taxpayer argued in pertinent part that the Government was improperly allowed to proceed on an assignment of income theory and the Government failed to prove its case beyond a reasonable doubt. The taxpayer asserted that Inc. assigned its contract to Ltd., and, therefore, the $1.3 million payment was taxable to Ltd. The Court of Appeals rejected the taxpayer's arguments.

With regard to the assignment of income doctrine, the Court of Appeals stated:

Before proceeding, we shall first explain, as completely as possible, why we have rejected as manifestly unreasonable certain of the credibility determinations and associated legal conclusions in the STJ report.

As outlined below, the STJ report reflects a fundamental misunderstanding regarding respondent's theory as to the means and manner by which Kanter, Ballard, and Lisle conducted the kickback scheme. Further, the analysis in the STJ report is based on the misconception that respondent conceded IRA, THC, and other Kanter-related entities were not shams. As a result, the question of the validity of these entities was never broached. These errors and others are explored in greater detail below.

Respondent argued that Kanter, Ballard, and Lisle did not disclose their scheme to Schaffel, Frey, Schnitzer, and Eulich. Respondent's Opening Brief at 568-567, quoted supra p. 71, included a discussion describing the kickback scheme as a matter that generally was known only to Kanter, Ballard, and Lisle. Respondent theorized that Ballard and Lisle agreed to steer Prudential business to The Five (and Lisle agreed to steer Travelers business to Schaffel) with the understanding that Kanter would share with Ballard and Lisle any fees he was able to obtain from The Five. In other words, respondent conceded that Schaffel, Frey, Schnitzer, and Eulich were not aware Ballard and Lisle were using their influence to steer business to them. In respondent's view, Schaffel, Frey, Schnitzer, and Eulich simply agreed to pay Kanter if he was successful in influencing his clients and other wealthy contacts in the real estate industry to generate business for them. Having misconstrued respondent's position, the STJ report repeatedly cites the testimony of Schaffel, Frey, Schnitzer, and Eulich as compelling evidence in support of its conclusion that Kanter, Ballard, and Lisle did not engage in a kickback scheme.

We acknowledge the STJ report also credits Kanter and Ballard's testimony, and Lisle's statement to IRS agents, that they were not engaged in a kickback scheme. As we shall discuss in significant detail below, it was manifestly unreasonable to give any credence to this testimony.

Proceeding on the misconception that respondent conceded IRA and THC were valid entities for tax purposes, the STJ report, at 81-82, summarily concludes that the assignment of income doctrine is inapplicable to payments IRA and THC received from PMS, Essex Partnership, and Hyatt/KWJ Corp. because "IRA and/or THC owned the property interests or property rights that generated the income in question." No consideration is given to whether IRA's and THC's interests were nominal or illusory. In connection with the foregoing, the STJ report, at 82-84, concludes the payments from Frey and Schaffel to IRA and/or THC did not represent an assignment of income because "IRA and THC * * * exercised significant control over Kanter's activities",¹⁰⁹ and Frey and Schaffel both entered "into an agreement to obtain the services from IRA and/or THC." Again, no consideration is given to whether IRA and THC merely served as Kanter's alter egos. Because respondent never conceded that IRA and THC were not shams, these portions of the STJ report are manifestly unreasonable.¹¹⁰

The STJ report, at 79, does include a brief discussion of the validity of loans to Ballard's and Lisle's grantor trusts. The STJ report, at 79 note 32, rejects Kanter's testimony that IRA made nonrecourse loans to Ballard's and Lisle's grantor trusts because the movie investments underlying those loans "were particularly promising". The STJ report acknowledges a lender operating at arm's length would have demanded some financial guaranty or collateral from the grantors of those trusts before extending those loans. The STJ report also acknowledges that Ballard and Lisle were valuable business contacts to Kanter and Kanter traded on those contacts to obtain "business arrangements with other third parties". Id. at 79. Despite these observations, the STJ report simply concludes Kanter "may have helped to arrange favorable loans for Ballard and Lisle out of gratitude for their friendship and the business advantages that friendship conferred" upon Kanter.¹¹¹Id. at 80. A detailed analysis of the magnitude, validity, and treatment of all loans that Ballard, Lisle, and their grantor trusts received from IRA, IFI, BWK, and other Kanter-related entities is lacking in the STJ report.

D. Summary of Kanter's, Ballard's, and Lisle's Transactions With The Five

We have often emphasized that fraud may be proved by circumstantial evidence because direct evidence of fraud generally is not available. See, e.g., Niedringhaus v. Commissioner, 99 T.C. 202, 210 (1992). More often than not (and as is certainly the case here), fraud can be established only through circumstantial evidence and the inferences to be drawn therefrom. See, e.g., DiLeo v. Commissioner, 96 T.C. 858, 874 (1991).

There is direct evidence the payments from The Five to IRA and THC represented income earned by Kanter. The transactions in question in these cases, however, were carried out in such a way that respondent must rely on circumstantial evidence in support of his determination that Ballard and Lisle earned substantial portions of the payments from The Five. There is no direct evidence that Kanter, Ballard, and Lisle agreed to share the payments from The Five, nor is there much in the way of direct evidence that Ballard and Lisle used their influence to steer Prudential or Travelers business to The Five. As explained below, however, there is plenty of evidence that Kanter, Ballard, and Lisle had the opportunity and wherewithal to carry out the alleged scheme. Ballard and Lisle certainly were in a position to influence Prudential and Travelers to award business to The Five, and to varying degrees they were directly involved in the decisions that led to Prudential's and Travelers' business dealings with The Five. Those factors, in combination with the flow of funds -- the fairly precise division of the proceeds of the scheme among the three -- remove all doubt in these cases in respondent's favor. We conclude that all the circumstances, when gathered together and viewed as a whole, constitute compelling and unmistakable evidence that Kanter, Ballard, and Lisle earned the income in question and Kanter's and Ballard's conduct in these matters was fraudulent.¹¹²

Kanter, an experienced and knowledgeable tax attorney, established a complex web of corporations, partnerships, and trusts as part of a plan to receive, disguise, launder, and distribute payments from The Five to himself, Ballard, and Lisle. The complex laundering mechanism of sham corporations and other entities that Kanter put together included among others IRA, THC, Carlco, TMT, BWK, KWJ Partnership, Essex Partnership, Zeus, IFI, HELO, TACI, and PSAC.

Ballard and Lisle were sophisticated and experienced businessmen who held two of the highest ranking executive positions within the real estate division at Prudential's national headquarters. Ballard later was a partner at Goldman Sachs. Lisle later held the highest ranking executive position within the real estate division at Travelers. Kanter, Ballard, and Lisle fully understood and appreciated their obligations to report income correctly and to pay taxes on that income. It was a conflict of interest for Ballard or Lisle to have received compensation in any way (directly or indirectly) with funds Kanter received in connection with introductions he made to Ballard or Lisle. Exh. 2030, at 31.

Kanter had many influential clients and business contacts involved in commercial property management and major hotel management businesses. Kanter represented the Pritzkers (the founders of Hyatt Corp.) and had longstanding friendships with Ballard and Lisle. Thus, Kanter marketed himself as more than just an attorney to his clients and commercial real estate professionals -- he offered additional services such as raising capital and using his influential contacts to generate business. In return for these services, Kanter demanded and routinely received a percentage or share of the fees and profits that the business opportunities generated for his business associates.

Beginning in the early to mid-1970s, Kanter, Ballard, and Lisle concluded that, with Ballard's and Lisle's positions of authority at Prudential, and Kanter acting as a broker/intermediary, the three together could generate and share enormous fees and profits. The three men recognized that Kanter's skills as an attorney, combined with his client list and business contacts in the commercial real estate industry, neatly complemented Ballard's and Lisle's ability to influence Prudential's business decisions pertaining to its large commercial real estate holdings throughout the country. Accordingly, without disclosing Ballard's and Lisle's direct roles in the scheme, Kanter approached various businessmen, including Schaffel, Frey, Schnitzer, and Eulich, and offered to assist them in raising capital and/or obtaining property management contracts for their businesses in exchange for a share in the fees or profits generated by these business opportunities. Although Kanter arranged to have these fees and profits paid to IRA or THC (or their subsidiaries), Schaffel, Frey, Schnitzer, and Eulich uniformly stated that they were relying on Kanter, and Kanter alone, to provide them with the additional business opportunities they were seeking. Largely unbeknownst to Schaffel, Frey, Schnitzer, and Eulich, however, Kanter, Ballard, and Lisle had agreed to share any fees and profits paid to Kanter to the extent that Ballard and Lisle were able to exert their influence to steer Prudential business to Kanter's contacts.

Considering their relative positions, Kanter, Ballard, and Lisle agreed to share the fees and profits 45 percent each to Ballard and Lisle and 10 percent to Kanter. Kanter's smaller share of the payments reflected the fact that Ballard and Lisle really controlled the purse strings and Kanter's role primarily was to (1) set up fee-sharing arrangements with other businessmen, and (2) structure entities and arrange the accounting measures needed to disguise the true nature of the payments, and (3) do his best to shelter the payments from Federal income tax. Kanter and Lisle agreed to a similar arrangement after Lisle moved on to Travelers.

In addition to his agreement with Ballard and Lisle, Kanter arranged some transactions so that he could be compensated separately through payments to THC. Kanter made such arrangements with regard to transactions with Frey and Eulich.

The Hyatt transaction, the event that first brought Kanter, Ballard, and Lisle together in the early 1970s, was carried out in a slightly different fashion, as we shall explain in detail below.

The Five received additional business as a result of Kanter's, Ballard's, and Lisle's efforts and compensated Kanter (through payments to IRA, THC, and other Kanter-related entities). IRA, THC, and the other Kanter-related entities did not earn any of the amounts paid to them by The Five. IRA, THC, and the other Kanter-related entities performed no services, and they merely served as nominees or conduits to receive payments from The Five. With regard to the transactions with The Five, Kanter was not an agent, officer, or employee of IRA or its subsidiaries during the years at issue, except in 1989 after the IRS began its investigation. Kanter was not controlled by IRA. To the contrary, Kanter controlled IRA.

The payments from The Five were distributed by various means either directly to Ballard, Lisle, and Kanter or indirectly through loans, investments, or consulting payments to them, their family members, or trusts and/or other entities established for the benefit of their families. To conceal Ballard's and Lisle's involvement in the scheme, and in an attempt to avoid having to report the amounts earned from the scheme on their individual tax returns, Kanter established TMT to serve as Ballard's alter ego, and Carlco to serve as Lisle's alter ego. The funds that Kanter transferred to TMT and Carlco were Ballard's and Lisle's shares of the fees and profits earned on the transactions with The Five. Ballard and Lisle owned TMT and Carlco, respectively, and they had unfettered use and enjoyment of the assets held nominally by those corporations. FPC Subventure Partnership was a conduit through which Kanter passed to Lisle his share of fees paid to Kanter by Schaffel in regard to Travelers transactions.

After winning the Houston Hyatt Hotel management contract, A.N. Pritzker wanted to submit a bid for Hyatt Corp. on the Embarcadero Hotel management contract. Lisle, however, was opposed to such a bid because Hyatt Corp. was proposing to build another hotel in the San Francisco area. A.N. Pritzker somehow came to believe that Weaver might be able to influence Lisle to allow Hyatt Corp. to submit a bid on the Embarcadero Hotel. In this regard, A.N. Pritzker agreed with Weaver that if Weaver could persuade Lisle to allow Hyatt Corp. to submit a bid on the contract, and if Hyatt Corp. were awarded the Embarcadero Hotel management contract, Hyatt Corp. would pay Weaver 10 percent of Hyatt Corp.'s profits on the management contract.

Lisle and Ballard were both present at the Embarcadero Hotel bid meeting. Ballard was assigned to attend the Embarcadero Hotel bid meeting and evaluate the various bids.

Weaver's effort to influence Lisle was successful. Unexpectedly, Intercontinental Co., one of the bidders, withdrew at the last minute and did not attend the bid meeting. A second bidder, Del Webb, who surprisingly attended the meeting in person (as opposed to sending a representative), refused to submit a bid because he believed he had already been awarded the contract. In the absence of a competing bid, Hyatt Corp. was awarded the Embarcadero Hotel management contract on the same terms on which it had agreed to manage the Houston Hyatt Hotel.

The record reflects that Weaver did much more than simply influence Lisle to permit Hyatt Corp. to submit a bid on the Embarcadero Hotel management contract. After Hyatt Corp. won the Embarcadero Hotel management contract, Hyatt Corp. entered into an agreement to pay 10 percent of Hyatt Corp.'s annual "net cash profits" from the contract to KWJ Corp., Weaver's closely held corporation. The Hyatt/KWJ agreement stated that Weaver "has been the principal factor in bringing the parties together and aiding in the negotiations" with regard to the Embarcadero Hotel management contract. In addition, the Hyatt/KWJ agreement was executed under the unusual circumstances that initially only A.N. Pritzker and his two sons knew the agreement existed. When other Hyatt Corp. executives later investigated the matter (including Friend -- A.N. Pritzker's son-in-law), they determined the Hyatt/KWJ agreement represented a reward to Weaver for his "substantial influence" in "arranging the management agreement" on the Embarcadero Hotel between Hyatt Corp. and Prudential.

We infer from all the facts and circumstances that Weaver recognized he would gain nothing by simply persuading Lisle to permit Hyatt Corp. to bid on the Embarcadero Hotel management contract. Weaver would be compensated only if Hyatt Corp. were to win the bidding on the contract. Consequently, Weaver informed Lisle and Ballard of A.N. Pritzker's promise to pay 10 percent of the Embarcadero Hotel management contract to Weaver, and Weaver agreed to share any payments he might receive from Hyatt Corp. with Ballard and Lisle if they used their influence to arrange for Hyatt Corp. to win the contract. Lisle and Ballard agreed to Weaver's proposal, and they arranged for Hyatt Corp. to win the contract. That Weaver did more than simply persuade Lisle to permit Hyatt Corp. to bid on the Embarcadero Hotel contract is evidenced by the Hyatt Corp. internal documents which stated that Weaver "arranged" the contract for Hyatt Corp.

The record indicates Kanter became aware of the Hyatt/KWJ agreement in the early 1970s when A.N. Pritzker presented the matter to him seeking advice. During this same period, Kanter was assisting Ballard and Lisle in establishing the grantor trusts they would use to invest in his movie shelters, and Kanter initiated discussions with Weaver regarding the sale of KWJ Corp. to IRA. We infer from the timing of these events that Kanter learned that Weaver agreed to share with Lisle and Ballard any payments that KWJ Corp. might receive under the Hyatt/KWJ agreement, and Kanter was offered a share of these payments in exchange for structuring the receipt and disbursement of the payments to the participants in a manner that would conceal Lisle's and Ballard's involvement in the matter. In particular, Kanter arranged IRA's purchase of KWJ Corp., the liquidation of KWJ Corp., and the formation of KWJ Partnership.

The transfer of KWJ Corp. to IRA was facilitated under the cover of an open-ended option (with no apparent independent value) that Weaver granted to IRA in 1976 to purchase KWJ Corp. for $150,000. Kanter's testimony that Weaver entered into this option agreement because he needed the money is wholly discredited by the fact that Weaver received nothing under the option agreement until mid-1980 -- 4 years later.

Although there was some initial discord between Hyatt Corp. and Weaver regarding the payments that KWJ Corp. would receive under the Hyatt/KWJ agreement, we attribute this development to the Pritzkers' reputation as aggressive negotiators who wanted to pay as little as possible to KWJ Corp. Nevertheless, Hyatt Corp. did pay substantial sums to KWJ Corp. pursuant to the Hyatt/KWJ agreement, and, as described in the flow-of-funds analysis below, approximately 70 percent of those payments were transferred through IRA to KWJ Partnership and on to Carlco, TMT, and BWK in a 45/45/10 percent split. KWJ Partnership was also used as a conduit to transfer funds to Ballard's and Lisle's adult children in the form of so-called consulting payments.

Kanter, Ballard, and Lisle earned the income associated with the portion of the Hyatt Corp. payments that were routed through IRA and KWJ Partnership. Kanter, Ballard, and Lisle attempted to assign that income to IRA and later to KWJ Partnership and its partners, Carlco, TMT, and BWK. Kanter, Ballard, and Lisle failed to report this income on their own tax returns.

Through the Hyatt transaction, Kanter, Ballard, and Lisle came to realize that Kanter's skills as an attorney, his client list, and his business contacts in the commercial real estate industry neatly complemented Ballard's and Lisle's ability to influence Prudential's business decisions pertaining to its large commercial real estate holdings throughout the country. The Hyatt transaction set the stage for Kanter's, Ballard's and Lisle's dealings with Schaffel, Frey, Schnitzer, and Eulich, summarized below.

While Ballard and Lisle were still employed at Prudential, Schaffel received (1) real estate broker's fees on the sale of IBM's headquarters building to Prudential, (2) fees related to Prudential construction contracts awarded to Torcon, and (3) fees related to financing that Prudential provided for Walters's development projects. Schaffel shared these fees with Kanter by way of payments to IRA.

Although some of the Prudential transactions that generated fees for Schaffel were initiated after Ballard and Lisle left Prudential, the inference may fairly be drawn that those transactions were an outgrowth of Ballard's and Lisle's earlier decisions to do business with Schaffel, which allowed Schaffel (and his clients) to establish a favorable reputation with Prudential.

In 1982, Lisle left Prudential and accepted a position as the head of Travelers' real estate department. Pursuant to his agreement with Kanter, Lisle assisted Schaffel by approving a number of financing deals between Travelers and Walters for various development projects. Schaffel remitted one payment to IRA arising from a Travelers financing deal that he brokered shortly after Lisle began working at Travelers. Schaffel then balked at making any additional payments to IRA. A dispute between Schaffel and Kanter ensued, and Kanter convinced Schaffel that he was obliged to continue to share with Kanter any fees and commissions that he might earn on Travelers financing transactions. At this point, Schaffel did not want to remit any further payments to IRA, and Kanter directed Schaffel to make his payments to THC.

Although Schaffel remitted his payments to either IRA or THC, those entities were used only as conduits to appease Schaffel's concerns over the legality of sharing broker's fees with a nonbroker. There is no evidence in the record that anyone representing IRA or THC was "instrumental or helpful" in obtaining financing from Prudential or Travelers for Walters's development projects or in obtaining Prudential construction contracts for Torcon.

Schaffel understood that Kanter himself would exert influence in an attempt to obtain Prudential and Travelers business for Schaffel and his clients. We conclude Kanter obtained such business from Prudential with the help of Ballard and Lisle, and from Travelers with the help of Lisle. There is no direct evidence that Kanter agreed to share with Ballard and Lisle any payments he might receive from Schaffel. However, a number of factors, including the dinner meeting in New York, Ballard's immediate role in Prudential's purchase of the IBM building, Ballard's and Lisle's ability to influence Prudential's awards of construction contracts to Torcon and financing transactions for Walters's projects, Lisle's direct role in awarding Travelers financing for Walters's projects, the details concerning the Kanter/Schaffel fee dispute, and the divisions of the Schaffel payments made to IRA and THC as discussed in the flow-of-funds analysis below, provide compelling circumstantial evidence that Kanter, Ballard, and Lisle agreed to share the Schaffel payments. Consequently, for tax purposes, Kanter, Ballard, and Lisle were the true earners of the fees that Schaffel paid to IRA on Prudential transactions, and Kanter and Lisle were the true earners of the fees that Schaffel paid to IRA and THC on Travelers transactions.

Kanter used IRA as a repository for the Schaffel payments and as a conduit to channel the payments to himself, Ballard, and Lisle. Kanter, Ballard, and Lisle attempted to assign to IRA the income they earned from Schaffel, and they failed to report their shares of that income on their individual returns. As discussed in the flow-of-funds analysis below, Kanter later transferred Ballard's and Lisle's shares of the fees that Schaffel paid to IRA to them through TMT and Carlco, and he received his own share through BWK.

Kanter and Lisle attempted to assign income that they earned on Travelers transactions to THC, and they failed to report that income on their individual returns. There is insufficient evidence to demonstrate that funds that Schaffel paid to THC were distributed directly to Lisle. Nevertheless, as discussed in the flow-of-funds analysis below, Kanter transferred at least a portion of Lisle's share of Travelers fees to Lisle through FPC Subventure Partnership.

Kanter also arranged for subsidiaries of IRA (Zeus) and of THC (Zion) to invest in some of Frey's projects as limited partners.

In early 1980, Ballard approved the sale by a pension fund managed by Prudential of a large apartment complex in Florida known as Village of Kings Creek to a limited partnership organized by Frey. Ballard visited the project during the conversion period. Frey was very successful in converting the property to condominiums. Shortly thereafter, in the fall of 1981, Prudential entered into a several joint venture condominium conversion projects with Frey (under which Frey managed the conversion of Prudential properties into condominiums).

At this time, Kanter and Frey committed their earlier oral fee-sharing agreement to writing. The Frey/THC participation agreement provided that for condominium conversion projects involving Prudential properties, and any future condominium conversion projects not involving Prudential properties, THC and Frey would participate in capital contributions and profits and losses as 33-percent and 67-percent partners, respectively. In addition, after October 1, 1981, THC would receive 5 percent of any development fees derived from any condominium conversion projects not involving Prudential properties. Frey agreed to share development fees with THC as a way to compensate Kanter for bringing investors and capital to his condominium conversion projects.

The Frey/Zeus agreement formalized Frey's and Kanter's prior oral agreement to share development fees and expanded that agreement to include "assigned profits" on Prudential condominium conversion projects. In particular, Frey agreed to remit to Zeus a 5-percent share of development fees and a 20-percent share of assigned profits earned on Prudential conversion projects because Kanter promised to use his influence to aid Frey in obtaining additional condominium conversion projects from Prudential.

There is no direct documentary evidence that Kanter agreed to share with Ballard and Lisle any payments he might receive from Frey. Nevertheless, considering all the circumstances, including Ballard's role in the Village of King's Creek transaction, the numerous Prudential projects initiated with Frey in the fall of 1981, and the division of the Frey payments as discussed in the flow-of-funds analysis below, we infer Kanter surreptitiously agreed with Ballard and Lisle that if they used their positions of authority at Prudential to influence Prudential to contract with Frey as the developer in the conversion of Prudential properties, Kanter would share with Ballard and Lisle the development fees and assigned profits payments that he expected to receive from Frey. Kanter also agreed to share with Ballard and Lisle any profits that Zeus might make by participating as a limited partner in various Frey partnerships.

The Frey-Zeus agreement reflected Frey's recognition that Kanter's influence in delivering several Prudential condominium projects in the summer and fall of 1981 was extremely valuable. At a time when investors were aggressively competing for properties to convert to condominiums and for capital to complete those conversions, Prudential provided a ready supply of such properties, and these projects did not require large infusions of capital.

In 1984, Frey, Kanter, and others formed BJF Partnership to engage in condominium conversion projects. The BJF Partnership agreement included a list of assets that the partners contributed to the partnership. Among the listed items were two participation agreements -- the Frey/THC agreement and the Frey/Zeus agreement dated October 21, 1981. Kanter, acting on behalf of THC, transferred to BJF Partnership rights to the Frey/Zeus agreement. Kanter, however, asserts that he neither owned nor controlled IRA or Zeus.

Frey made payments to Zeus and THC. By directing Frey to make payments to Zeus on Prudential condominium conversion projects, Kanter, Ballard and Lisle attempted to assign income that they earned on those projects to Zeus. By directing Frey to make payments to THC, Kanter attempted to assign income that he earned on non-Prudential condominium conversion projects to THC.

In 1977, Schnitzer and Kanter discussed Century's possible sale of a 47.5-percent stock interest in PMS to IRA. Kanter told Schnitzer that he had various business contacts, including the Pritzker family, through which Kanter could obtain additional property management business for PMS. Before agreeing to sell PMS's common stock to IRA, Schnitzer conferred with Ballard to obtain his view as to whether Kanter could deliver additional management contracts for PMS. In November 1977, Century sold a 47.5-percent stock interest in PMS to IRA at a bargain price of $150,000.

Schnitzer and Ross were not relying on IRA, Schott, or Weisgal to generate additional business opportunities for PMS. Schnitzer and Ross were relying solely on Kanter to obtain additional business opportunities for PMS.

During the period 1976 to 1979, PMS expanded its portfolio of management contracts, and its growth was attributable in large measure to additional contracts from Prudential, which represented approximately 40 percent of its revenue.

In late March 1979, Schnitzer informed Kanter that he was disappointed with Kanter's failure to deliver additional property management business for PMS, and he wanted to buy back the PMS stock held by IRA. Kanter made a counteroffer to purchase all of the PMS stock that Schnitzer owned for $3.1 million. Ultimately, Schnitzer agreed to pay IRA $3.1 for its PMS stock with payments to be made in installments over 10 years. In February 1989, PMS made an early, discounted final payment to PSAC, which transferred the funds to IRA for distribution to Carlco, TMT, and BWK.

Once again, although there is no direct evidence of an agreement among Kanter, Ballard, and Lisle to share profits from the PMS transaction, the surrounding circumstances strongly support an inference that an agreement was in place. We begin with the fact that Ballard and Lisle were aware that Schnitzer was so anxious to expand PMS's management business that he was willing to part with a large share of the company at a bargain price. Against this backdrop, Schnitzer conferred with Ballard before agreeing to sell a large stake in PMS to IRA. Ballard and Lisle, of course, were in a position to increase PMS's portfolio of Prudential management contracts. Considering that the PMS installment payments eventually were divided among Carlco, TMT, and BWK (as discussed in the flow-of-funds analysis below), we infer that Kanter, Ballard, and Lisle recognized they could earn easy profits by acquiring stock in PMS, and they agreed to share those profits before IRA acquired the PMS stock.

Kanter, Ballard, and Lisle used IRA as a conduit to obtain a 47.5-stock interest in PMS and to conceal Ballard's and Lisle's involvement in the matter. The substantial appreciation that IRA realized between the $150,000 purchase price for the PMS stock in November 1977 and the $3.1 million sale price in August 1979 -- the latter amount being paid in installments over 10 years -- represented income that was earned by Kanter, Ballard, and Lisle. Kanter, Ballard, and Lisle improperly attempted to assign income from the PMS transaction to IRA. As discussed in the flow-of-funds analysis below, Kanter shared the income derived from the PMS stock sale with Ballard and Lisle through distributions to TMT, Carlco, and BWK.

Beginning in the fall of 1981 and into early 1982, Kanter and Eulich organized Essex Corp. and Essex Partnership. The organization of these entities coincided with Prudential's decision to award the management contracts for the Gateway Hilton (fall 1981) and the Midland Hilton (no later than February 1982) to Connolly (the onsite manager of the Gateway Hilton). Ballard and Lisle were instrumental in awarding these contracts to Connolly, even though they knew that Connolly did not have the support services (personnel) to manage the hotels on his own.

Ballard introduced Eulich to Connolly as someone who would assist Connolly with the support services he needed to properly manage the Gateway Hilton. Eulich then organized Gateway Hotel Management Co. (GHM) to make it appear as if Connolly was the owner of a hotel management company. In early 1982, Connolly and Essex Corp. executed the GHM option agreement, which they purportedly agreed to on September 18, 1981, and which recited that (1) Connolly owned 100 percent of GHM, (2) Connolly was transferring to Essex Corp. an option to acquire 80 percent of GHM (80 shares at $100 per share) for 10 years and, (3) in exchange for the option, Essex Corp. would pay Connolly $1,000 per year for 10 years. The record also includes the Connolly promissory note dated December 15, 1981, from Connolly to Essex Corp., in the amount of $8,000, subject to 8 percent interest, payable for 9 years with a final balloon payment due in 1991. Because the payments under the Essex option offset the amounts due from Connolly under the promissory note, we infer that these transactions were nothing more than a sham to make it appear that Connolly had adequately capitalized GHM.¹¹⁴ At best, GHM was capitalized with $2,000.

The partners of Essex Partnership and their partnership interests were as follows:

                                   Percentage

Essex Partnership's stated purposes were (1) "To engage generally in the consulting business and as a liaison intermediary between owners and operators of hotel properties", and (2) "To enter into other partnership agreements * * *, to become a member of a joint venture, or to participate in some other form of syndication for investment; and to buy, sell, lease, and deal in services, personal property, and real property."

In connection with the formation of Essex Partnership, GHM and MHM entered into separate representation and marketing agreements with Essex Partnership. GHM agreed to pay to Essex Partnership 75 percent of its fees on GHM's management contracts on the Gateway Hilton and the Midland Hilton. MHM agreed to pay to Essex Partnership 30 percent of its management fees from the operation of the Madison Hotel and 43 percent of the fees from the operation of the Allentown Hilton. In return, Essex Partnership agreed to (1) "perform liaison functions" between certain hotel owners and GHM and MHM in connection with management contracts between such parties, (2) "perform liaison functions" between the owners of any additional properties which it was instrumental in securing for management by GHM or MHM, (3) "use its best efforts to maintain satisfactory relations" between the property owners and GHM and MHM "and to maintain sufficient personnel to properly perform such [management] functions", and (4) "use its best efforts to secure management contracts" satisfactory to GHM and MHM.

Essex Partnership had no offices and no employees. Very few, if any, capital contributions were made to Essex Partnership. The record reflects that personnel associated with MHM in effect provided all the financial and accounting services that GHM required to fulfill its hotel management contracts. For the most part, Connolly simply continued to serve as the onsite manager of the Gateway Hilton.

In late 1983, Prudential awarded to MHM the hotel management contract for the Twin Sixties Hotel. Shortly thereafter, MHM and Essex Partnership modified their representation and marketing agreement to provide that MHM would pay 70 percent of its management fees from the Madison Hotel and 57 percent of its management fees from the Allentown Hilton and the newly acquired Twin Sixties Hotel management contract. On January 1, 1986, Connolly executed a new representation and marketing agreement on behalf of GHM which provided that GHM would pay to Essex Partnership 40 percent of the fees earned on the Gateway Hilton and Midland Hilton management contracts.

Over time, the total fees that MHM paid to Essex Partnership generally equaled the total fees that GHM paid to the partnership, and the total fees MHM paid to the partnership roughly approximated MHM's distributive share of partnership income as a 47.5-percent partner in Essex Partnership. However, as indicated previously, MHM was not paid directly for the substantial services its employees rendered to GHM. Rather, as a partner in Essex Partnership, MHM received 47.5 percent of the partnership's income. Although IRA and THC, as partners, also received a combined 47.5 percent of the income of Essex Partnership, IRA and THC, in contrast to MHM, provided no services to GHM.

Eulich and MHM's top management essentially viewed Essex Partnership as a marketing and sales device whereby MHM eventually might obtain more management contracts for large hotels. In addition, MHM needed to increase its level of experience and expertise in managing and operating large hotels. Because of the substantial services that MHM was providing GHM, Eulich considered the Gateway Hilton and Midland Hilton management contracts to be part of MHM's management business.

Connolly could not explain the benefits that GHM would receive under the GHM/Essex representation and marketing agreement; he did not expect anyone at Essex Partnership to perform liaison functions between himself and Prudential. From MHM's standpoint, Formby did not know what liaison functions Essex Partnership was expected to perform for GHM, and he believed that no such activities occurred. James, MHM's president, could not identify a specific person or entity who would have acted as a liaison between the owners and operators of the hotel properties in question. James did not know that IRA and THC were partners in Essex Partnership until he was shown the partnership agreement at trial. Eulich had never seen the Essex Partnership agreement or the representation and marketing agreements between MHM and Essex Partnership. Eulich could not explain how Essex Partnership would serve as "liaison intermediary between the owners and operators of hotel properties". There were no officers or employees at Essex Partnership who could have engaged in consulting or acted as liaisons.

Between 1982 and 1988, GHM paid $1,334,601 and MHM paid $1,563,412 to Essex Partnership. During 1982 through 1989, Essex Partnership distributed $788,452 to IRA and $645,099 to THC.

On December 31, 1984, IRA transferred its Essex Partnership interest to Carlco, TMT, and BWK. Carlco and TMT each received an 11.75-percent partnership interest in Essex, while BWK received a 2.6125-percent partnership interest in Essex. Essex Partnership apparently was not informed of the transfer and continued to make partnership distributions to IRA.

The record reflects that Connolly was little more than a pawn with regard to Essex Partnership. Connolly knew very little about GHM or Essex Partnership, and we infer from his testimony that he was happy simply to receive a substantial salary for ostensibly managing both the Gateway Hilton and the Midland Hilton. In fact, MHM provided the necessary management support services for all of the hotels in question. Kanter, Ballard, and Lisle used Essex Partnership as a conduit to receive a portion of the management fees paid to GHM on the Gateway Hilton and Midland Hilton management contracts (through distributions to IRA), and Kanter received a separate portion of those same management fees (through distributions to THC). As discussed in the flow-offunds analysis below, the distributions that IRA received from Essex Partnership were distributed to Carlco, TMT, and BWK. Essex Partnership represented an effort by Kanter, Ballard, and Lisle to assign to IRA and/or THC income that they earned.

The Court's additional findings of fact regarding the flow of funds from The Five to THC, and ultimately to Kanter and Lisle, are set forth supra pp. 207-213. Although the funds paid by The Five to THC could not be traced directly to Kanter and Lisle because of a lack of complete general ledgers for THC and TACI for the years in question, we are satisfied that the transfers of funds between THC, TACI, and Kanter documented in the record demonstrate that Kanter used the funds from THC as his own. We likewise conclude that Kanter arranged FPC Subventure Partnership as a conduit to pass to Lisle at least a portion of Lisle's share of the fees that Schaffel paid to THC.

The following summary (subsections 1-4) highlights the more important aspects of the flow of funds.

In 1984, IRA began distributing some of its cash and partnership interests to Carlco, TMT, and BWK in a 45/45/10 percent split. Specifically, during 1984, IRA transferred approximately $4.2 million to Carlco, TMT, and BWK. The distributions to Carlco and TMT represented a large portion of Lisle's and Ballard's shares of the payments that IRA received from The Five.

During the period 1984 through 1989, The Five made payments to IRA (and Zeus) in the aggregate amount of $4.6 million. IRA distributed (1) $1,103,721 that it received from Hyatt Corp. to KWJ Partnership (and to Carlco, TMT, and BWK), and (2) $623,865 that it received from Essex Partnership to Carlco, TMT, and BWK. IRA also transferred to Carlco, TMT, and BWK $2,287,191 in installment payments that it received from PMS during 1984 to 1989.

Although there is no direct evidence that Zeus transferred to IRA the approximately $232,000 in payments that it received from Frey during 1984 and 1985, that amount nearly equals the approximately $250,000 that IRA lent to KWJ Partnership during 1985 to 1989 (which was used to make consulting payments to Ballard's and Lisle's adult children, discussed below).

By the end of 1989, IRA's records reflected that it had transferred capital contributions and paid-in capital to Carlco, TMT, and BWK as follows:

 Carlco                        TMT                      BWK

After the IRS began its examination, Kanter contacted Ballard and Lisle to discuss repayment of their debts. These discussions were merely postexamination window dressing.

During much of the period 1982 to 1989, KWJ Corp. and KWJ Partnership paid $1,000 per month to Ballard's and Lisle's adult children and deducted the payments (which totaled $313,000) as consulting fees. As the managers of Carlco and TMT, Lisle and Ballard were aware of and acquiesced in these payments. Although it appears that some of the children contacted Kanter at various times with recommendations and suggestions for investments, the record reflects that for many of the years in question they did little or nothing to earn the payments. In fact, in letters to the children terminating the payments in February 1990, Kanter stated that "no services appear to have been performed for a number of years", and Kanter explained that the payments had continued because IRA's president, Freeman, "paid no attention to the activities of * * * [IRA] and its affiliates, and those who were simply administering tasks on behalf of * * * [IRA] routinely continued to make payments to you". These payments represented Ballard's and Lisle's shares of some of the payments remitted to IRA by The Five that Ballard and Lisle attempted to assign to their children.

On the other hand, the approximately $2.8 million that Schaffel paid to THC between 1984 and 1986 (ostensibly as Kanter's share of the fees that Schaffel earned arranging Travelers financing for Walters's development projects) represented income earned by both Kanter and Lisle. Kanter and Lisle improperly attempted to assign this income to THC. As discussed below, Kanter passed at least a portion of Lisle's share of this income to Lisle through FPC Subventure Partnership.

Contrary to Kanter's testimony, Schaffel and Torcivia were not aware that Lisle was a partner in FPC Subventure Partnership.

In 1982, Kanter also transferred his 8-percent limited partnership interest in One River Partnership to FPC Subventure Partnership in exchange for a $2,000 promissory note.

During the years at issue, Kanter (who held an interest in FPC Subventure through grantor trusts) and Lisle reported distributive shares of FPC Subventure's partnership items of income, loss, deduction, and credit on their individual tax returns. However, Four Ponds Partnership and One River Partnership (1) reported net losses in 1981 to 1984 and 1987 to 1989 totaling $1,067,131, and (2) made cash distributions to its partners in 1981 to 1984 and 1987 to 1989 totaling $731,080. Approximately 7 percent of Four Ponds' and One Rivers' partnership losses, described above, flowed through to Lisle through FPC Subventure Partnership.

In addition to these favorable tax effects, during the period 1981 to 1989 Lisle received at least $682,520 in cash distributions from FPC Subventure Partnership.¹¹⁶ Consequently, FPC Subventure Partnership served for Lisle the dual purposes of (1) a tax shelter, and (2) a source of substantial cash distributions. Kanter structured FPC Subventure Partnership as a conduit to transfer to Lisle at least a portion of his share of payments remitted to THC.¹¹⁷

IRA's officers and directors, including Freeman and Weisgal, did not manage any business or provide any meaningful services to The Five. Kanter disclosed that for several years Freeman had been distracted by his own legal woes and did not manage IRA. Weisgal recalled very little regarding any matters concerning IRA's operations and was not aware of anyone at IRA who provided services to The Five.

Schaffel, Frey, Schnitzer, and Eulich uniformly testified that they were looking to Kanter, and Kanter alone, to use his influence with his wealthy and well-connected clients and business contacts in an effort to generate additional business opportunities for them. Kanter's statements in his dealings and negotiations with The Five are equally revealing that Kanter would be providing the services and expected to be compensated for those services. In the end, The Five entered into contracts with and made payments to IRA, THC, and their subsidiaries only because Kanter directed them to do so.

There is no evidence of any contract between IRA and Kanter, nor is there any evidence that IRA controlled Kanter's activities in any way. To the contrary, Kanter orchestrated all business matters concerning IRA or THC and their subsidiaries, and Kanter's instructions were carried out by administrators and bookkeepers including Freeman, Weisgal, Meyers, and Gallenberger. There is no evidence that anyone at IRA or THC provided any services to The Five. Kanter directed The Five to execute agreements with and make their payments to IRA, THC, and their subsidiaries in an effort to conceal that Kanter, Ballard, and Lisle earned the payments remitted by The Five. IRA, THC, and their subsidiaries were Kanter's alter egos. Kanter, Ballard, and Lisle improperly attempted to assign their income to IRA, THC, and their subsidiaries.

The record shows that (1) IRA acquired 1,000 shares of common stock of Carlco, of TMT, and of BWK in December 1983, and (2) Carlco preferred stock was issued to Christie Trust (Lisle's family trust), TMT preferred stock was issued to the Orient Trust (Ballard's family trust), and BWK preferred stock was issued to the BK Children's Trust (one of the Bea Ritch Trusts). The record, however, is devoid of stock ledgers or related information for these corporations after early 1984. Respondent requested a comprehensive set of corporate records for Carlco, TMT, and BWK; however, petitioners failed to produce such records for the period after 1984. Although the paper record (stock certificates) suggests that IRA owned a controlling interest in Carlco, TMT, and BWK, the manner in which Kanter, Ballard, and Lisle handled the assets that IRA transferred to those entities (discussed supra pp. 178-194) indicates that, in substance, Lisle owned Carlco, Ballard owned TMT, and Kanter owned BWK.

In 1984, Kanter directed IRA to transfer a substantial portion of its cash on hand to Carlco, TMT, and BWK in a 45/45/10 percent split. IRA also transferred to Carlco, TMT, and BWK its partnership interest in Essex Partnership and its interest in KWJ Corp. (both of which provided a steady stream of cash payments and distributions), and IRA distributed to Carlco, TMT, and BWK the annual installment payments that it received from PMS. These distributions did not, however, represent an allocation of IRA's "free cash-flow" as Kanter alleged. IRA was transferring to Carlco, TMT, and BWK shares of the payments derived (and to be derived) from transactions with The Five.

Two facts demonstrate that Kanter's explanation regarding the distributions to Carlco, TMT, and BWK are not to be believed. First, we note that the only asset transferred to Carlco, TMT, and BWK with no apparent connection to The Five was a portion of IRA's interest in Sherwood/Forest Activities Partnership. By our reckoning, this partnership did not provide any cashflow at all and merely served as a source of deductions to shelter from taxation a portion of Carlco's, TMT's, and BWK's income for 1984 to 1987. Kanter's explanation is also belied by the fact that IRA held large of amounts of cash during the period 1984 to 1989 (particularly 1987) that it invested in CDs rather than distribute to Carlco, TMT, and BWK. Thus, although Kanter recommended that Carlco, TMT, and BWK should receive funds from IRA in a 45/45/10 percent split of IRA's free cashflow, Kanter's recommendation was instead part of a preexisting agreement among Kanter, Ballard, and Lisle to share payments from The Five.

There likewise is no support for Kanter's assertion the allocations to Carlco, TMT, and BWK would allow for diversification of IRA's investments.¹¹⁹ While Lisle invested Carlco's assets primarily in municipal bonds, the record reflects that Ballard also invested up to 30 percent of TMT's assets in bonds, including municipal bonds. In addition, as of 1989, another 20 percent of TMT's assets was allocated to cash and notes receivable (many of which were due from Ballard). Under the circumstances, Kanter's purported asset allocation achieved very little in the way of diversification of investments.

Finally, Kanter's explanation for the removal of Carlco, TMT, and BWK from IRA's consolidated group of corporations for tax reporting purposes is implausible. First, even if it were logical to remove Carlco from IRA's consolidated group to protect IRA's interest deductions, this explanation does not clarify why TMT and BWK (which were to invest primarily in real estate and other miscellaneous investments, respectively) were likewise removed from the consolidated group. There was no indication that TMT's and BWK's planned investments would imperil IRA's tax deductions. Moreover, if Carlco, TMT, and BWK had truly remained subsidiaries of IRA as Kanter contended, their removal from IRA's consolidated group for tax-reporting purposes would have done nothing to shield Ballard and Lisle from oversight or second-guessing by IRA's officers.

In sum, IRA's transfers to Carlco, TMT, and BWK represented Lisle's, Ballard's, and Kanter's shares of the payments derived (and to be derived) from transactions with The Five. Further, Carlco, TMT, and BWK were removed from IRA's consolidated group to reflect the reality that those corporations were owned and controlled by Lisle, Ballard, and Kanter, respectively, and they would each be responsible for their own taxes going forward.

In addition, Carlco owned a 45-percent partnership interest in KWJ Partnership. IRA made substantial loans to KWJ Partnership which in turn KWJ Partnership used to make so-called consulting payments to Ballard's and Lisle's adult children during the period 1983 to 1989. Lisle was aware of and acquiesced in these payments, and he was aware that the children were not providing any meaningful services in exchange for the payments.

We conclude Lisle owned Carlco and all of its assets, and Lisle used Carlco as a conduit for receiving his share of the payments from The Five.

From 1984 through 1989, TMT lent $146,943 and $160,000 to Claude and Mary Ballard, respectively. Although Ballard purportedly arranged in December 1986 to repay the $160,000 loan to Mary Ballard with Macy's preferred stock, TMT's accounting records do not indicate that the $160,000 loan was ever repaid.

In 1986, TMT paid $100,000 for an asset described in TMT's general ledger as "LAND ST. FRANCIS COUNTY [ARKANSAS] 414.28 ACRE".¹²¹ This asset was subsequently removed from TMT's general ledger, and adjusting journal entries indicated that an asset identified as "Fairfield Planting Company" was transferred to Ballard, and Ballard's loans from TMT were increased by $100,000.

When Gallenberger was questioned about this transaction, she could not recall the details and suggested Ballard should be questioned on the matter. Ballard testified that (1) the transaction involved his acquisition of stock in Fairfield Planting Co., an S corporation involved in farm operations in Arkansas; (2) he owed TMT approximately $200,000 on the transaction; (3) TMT continued to receive "interest" on the deal; (4) he owned two-sevenths of Fairfield; (5) the initial Fairfield investment was $1,350,000, and the investment had increased in value to approximately $2,350,000; and (6) the Fairfield transaction was a good deal for TMT and a bad deal for him.

The record also includes a promissory note that Ballard purportedly executed on January 20, 1987, which provided (1) Ballard agreed to pay to TMT, on demand, the principal sum of $100,000, and (2) the note would not bear interest but TMT was entitled to receive 90 percent of the "dividends" paid to Ballard by Fairfield. At the same time, Ballard's wife, Mary Ballard, acting as TMT's president, and Ballard signed an agreement which stated that (1) Ballard was executing a note to TMT and was pledging 1,000 shares of Fairfield common stock as security for the note, and (2) TMT, as part of the transaction, agreed to advance in the future "any deficits incurred by * * * Ballard in the operations of Fairfield * * * and is to receive 90% of the dividends paid by Fairfield". Mary Ballard, acting in her individual capacity, and Ballard also signed an assignment which stated that "for the purpose of securing the payment of all indebtedness now owing, or which may at any time hereafter be owing" by Ballard to TMT, the Ballards assigned to TMT 1,000 shares of Fairfield common stock.

In 1987, TMT apparently paid an additional $20,344 to Fairfield, and this amount was treated as an additional loan to Ballard.

The Ballards reported Fairfield items of income and loss on their 1987, 1988, and 1989 tax returns.

Ballard's explanation for this transaction and petitioners' treatment of the matter in their reply brief are contradictory. It is not clear that TMT ever owned shares in Fairfield Planting Co. that it could transfer to Ballard. See Petitioners' Reply Brief at 625-626. In any event, Ballard's testimony suggests the asset he received, described by him as stock in Fairfield Planting Co., was worth considerably more than the $100,000 charged to him as a loan. Finally, the terms of Ballard's promissory note associated with this transaction suggest self-dealing and an effort to create an instrument for a debt that would never be repaid. In the absence of any evidence in the record that TMT ever received any payments (interest, dividends, or otherwise) attributable to Ballard's promissory note, we conclude that the promissory note was a sham.

TMT's records show that in 1988, TMT purportedly purchased $15,000 of stock in Ficom International, Inc., a corporation organized by Ballard's daughter, Melinda Ballard. The entry reflecting the investment includes a handwritten notation "W/O in 1989." In 1989, TMT recorded in its trial balance ledger a $15,000 long-term capital loss on its investment in Ficom. Adjusting journal entry No. 6 explained the writeoff as follows: "To w/o worthless stock of Ficom as per note on 1988 TB [trial balance]". TMT claimed this loss as a deduction on its 1989 tax return.

In addition, TMT owned a 45-percent partnership interest in KWJ Partnership. IRA made substantial loans to KWJ Partnership which in turn KWJ Partnership used to make so-called consulting payments to Ballard's and Lisle's adult children during the period 1983 to 1989. Ballard was aware of and acquiesced in these payments, and he was aware that the children were not providing any meaningful services in exchange for the payments.

Ballard made loans to himself and his family members from TMT's assets with no intention of repaying those loans, and he transferred property acquired by TMT to himself in exchange for an illusory promissory note. We conclude Ballard owned TMT and all of its assets, and Ballard used TMT as a conduit for receiving his share of the payments from The Five.

In April 1985, BWK lent $400,000 to Kanter. By the end of 1987, the $400,000 loan had not been repaid. In 1988 and 1989, the $400,000 loan was reduced by approximately $30,000 each year. Adjusting journal entries treated these loan reductions as salary that otherwise would have been paid to Kanter. There is no evidence that Kanter paid any interest on the $400,000 loan.

During the period 1987 to 1989, BWK lent a total of $236,000 to PSAC to support its operations. At the time the record in these cases was closed, PSAC had not repaid the loans from BWK.

We conclude Kanter owned BWK and all of its assets, and Kanter used BWK as a conduit for receiving his share of the payments from The Five.

We briefly list the following items (subsections 1-7) as further evidence that Kanter, Ballard, and Lisle earned the payments that The Five remitted to various Kanter-related entities.

Later, in August 1989, IRA issued checks for $22,618.80 each to Ballard and Lisle. After the checks were issued to Ballard and Lisle, IRA records reflected a transfer of $45,237 to KWJ Partnership on August 8, 1989. Also on August 8 and 15, 1989, IRA ledger entries reflected that the checks issued to Lisle and Ballard, respectively, were void. Despite the fact that IRA's ledger entries stated that these checks were voided, Lisle's 1989 return reflected that he actually cashed the check. Lisle reported $22,619 on his return as income from the "KJW [sic] Company." The checks issued to Ballard and Lisle reflected that Ballard and Lisle (as opposed to KWJ Partnership) earned shares of all Hyatt Corp. payments to KWJ Corp.

In addition, when BJF Partnership was formed in 1984, the partnership agreement recited that among the items transferred to the partnership by the partners were "Two Participation Agreements with Burton J. Kanter regarding certain condominium conversions. These agreements have been terminated with respect to new conversions." The BJF Partnership agreement included representation and warranty clauses under which Kanter stated that (1) he did not need any consent, authorization, or approval to contribute the participation agreements to the partnership, and (2) the termination of the participation agreements was valid, binding, and effective. This transaction is significant because the participation agreements referred to were the Frey/Zeus agreement and the Frey/THC agreement. Contrary to Kanter's assertion that he did not own or control IRA or Zeus, this transaction suggests that Kanter exercised complete control over those entities.

In addition, the 1984 dispute between Schaffel and Kanter over whether Schaffel was required to continue making payments to IRA reveals that both Schaffel and Kanter understood that their fee-sharing agreement was inextricably tied to Ballard and Lisle. Schaffel hoped to restrict the fee-sharing agreement to Prudential transactions only,¹²² whereas Kanter maintained the agreement required Schaffel to share any fees arising from his business dealings with Ballard and Lisle wherever they might be employed.

In August 1989, Ballard submitted to the Compliance Department at Goldman Sachs a Request for Approval of Outside Business Activities and/or Private Investments Form. In response to a direction to provide a "Complete description of the investment or business affiliation. What is it and who else is involved in it as principals? Does it involve a public or private company?", Ballard answered, in part: "Farmland -- Have been buying and selling for years." If Ballard was managing TMT for IRA as he and Kanter contend, Ballard would have been required to disclose to Goldman Sachs that TMT and/or IRA were the principal owners of the farmland that Ballard was buying and selling.

The record also shows that Ballard did disclose to Goldman Sachs that he served as the director of an organization called ICM Property Investors. His involvement in this organization was through a "close friend" who controlled the organization. Ballard never submitted such a form to Goldman Sachs with respect to TMT because Ballard owned TMT.

Upon closer examination, Kanter's letters to the children are remarkable in that they demonstrate Kanter's attempt to rewrite history in the face of an expanding IRS examination. In fact, Kanter's letters were inconsistent with both the record in these cases and earlier explanations Kanter offered for the organization of Carlco, TMT, and BWK.

Recall that IRA liquidated KWJ Corp. in late 1983 and transferred its rights under the Hyatt Corp./KWJ agreement to Carlco, TMT, and BWK in a 45/45/10 percent split as part of an alleged free cashflow asset allocation. Carlco, TMT, and BWK in turn formed KWJ Partnership, which received both the Hyatt Corp. payments and loans from IRA (which were used to fund the payments to Ballard's and Lisle's children). Recall also Kanter's explanation that Carlco, TMT, and BWK were removed from IRA's consolidated group of corporations in 1984 in part to ensure Ballard and Lisle could manage TMT's and Carlco's assets (which included the cash distributions from KWJ Partnership and loans from IRA) without interference from IRA's officers. Consistent with this explanation, Ballard and Lisle, as TMT's and Carlco's managers, were fully cognizant of the payments that KWJ Partnership was making to their children. Kanter's letters contradict this scenario, are not credible, and represent an 11th-hour attempt by Kanter to recharacterize the payments to Ballard's and Lisle's children as a clerical or administrative error.

Kanter's letters were also inconsistent with the record in these cases to the extent Kanter suggested that no one was managing IRA during the latter half of the 1980s. Although Kanter's letters rang true in the sense that Freeman was not managing IRA (in fact, Freeman never managed IRA), the record in these cases amply demonstrates that someone was in firm control of IRA's affairs. Recall, for example, that in 1987 IRA (1) engaged in a complex transfer of notes with IFI and then sold 10 of those notes for $1 each to MAF, and (2) discounted and then wrote off as bad debts notes due from Ballard and Lisle individually. As had been the case all along, the person firmly in charge of IRA's affairs was Kanter.

Kanter arranged to conceal Ballard's and Lisle's roles in the scheme by funneling the payments from The Five to sham entities including IRA, THC, Carlco, TMT, BWK, and FPC Subventure Partnership. Those entities served no legitimate business purposes, and they were nothing more than the alter egos of their masters.

The following schedule lists the total amounts of payments from The Five to IRA during 1977 to 1989 and the portions of those payments that constitute income properly attributable to Kanter, Ballard, and Lisle:

           Total payments

           Total payments

In asserting that a taxpayer is liable for the addition to tax for fraud, the Commissioner has the burden of proving, by clear and convincing evidence, that some part of the underpayment for each year at issue was due to fraud. Sec. 7454(a); Rule 142(b). Consequently, the Commissioner must establish (1) an underpayment, and (2) that some part of the underpayment is due to fraud. King's Court Mobile Home Park, Inc. v. Commissioner, 98 T.C. 511, 515-516 (1992); Truesdell v. Commissioner, 89 T.C. 1280, 1301 (1987).

Fraud is an intentional wrongdoing by the taxpayer with the specific purpose of evading a tax known or believed to be owing. Stoltzfus v. United States, 398 F.2d 1002, 1004 (3d Cir. 1968); McGee v. Commissioner, 61 T.C. 249, 256 (1973), affd. 519 F.2d 1121 (5th Cir. 1975). The Commissioner's burden of proving fraud is met if it is shown that the taxpayer intended to evade taxes known to be owing by conduct intended to conceal, mislead, or otherwise prevent the collection of taxes. Stoltzfus v. United States, supra at 1004-1005; Rowlee v. Commissioner, 80 T.C. 1111, 1123 (1983).

The existence of fraud is a question of fact to be resolved from the entire record. DiLeo v. Commissioner, 96 T.C. 858, 874 (1991), affd. 959 F.2d 16 (2d Cir. 1992); Gajewski v. Commissioner, 67 T.C. 181, 199 (1976), affd. without published opinion 578 F.2d 1383 (8th Cir. 1978). The taxpayer's entire course of conduct can be indicative of fraud. Stone v. Commissioner, 56 T.C. 213, 224 (1971). Because fraud can rarely be established by direct proof of the taxpayer's intention, fraud may be established by circumstantial evidence and reasonable inferences drawn from the record. DiLeo v. Commissioner, supra at 874-875; Rowlee v. Commissioner, supra at 1123. However, the mere suspicion of fraud is insufficient because fraud is not to be inferred or presumed. Carter v. Campbell, 264 F.2d 930, 935 (5th Cir. 1959).

In Bradford v. Commissioner, 796 F.2d 303, 307 (9th Cir. 1986), affg. T.C. Memo. 1984-601, the U.S. Court of Appeals for the Ninth Circuit set forth a nonexclusive list of circumstantial factors that may give rise to a finding of fraudulent intent. Such "badges of fraud" include: (1) Understatement of income; (2) maintenance of inadequate records; (3) failure to file income tax returns; (4) implausible or inconsistent explanations of behavior; (5) concealment of assets; and (6) failure to cooperate with tax authorities.

In addition, substantial understatements of income for successive years are strong evidence of fraudulent intent. Rogers v. Commissioner, 111 F.2d 987, 989 (6th Cir. 1940), affg. 38 B.T.A. 16 (1938); Conforte v. Commissioner, 74 T.C. 1160, 1201 (1980), affd. in part and revd. on another issue 692 F.2d 587 (9th Cir. 1982); Otsuki v. Commissioner, 53 T.C. 96, 107-108 (1969); see also Baumgardner v. Commissioner, 251 F.2d 311, 316 (9th Cir. 1957), affg. T.C. Memo. 1956-112.

Kanter's campaign of obfuscation and delay was particularly evident during summons enforcement proceedings. The District Court, in two separate rulings, concluded Kanter failed to cooperate, acted in bad faith, and allowed documents to be destroyed even after the IRS summonses for those documents had been issued. First, the District Court observed: (1) Weisgal testified that, after receiving a summons to compel production of documents, some summoned documents relating to the Kanters had been turned over to TACI, and some documents were discarded as part of an alleged 3-year record retention policy;¹²⁴ and (2) Gallenberger testified that she disposed of some documents related to Kanter after receipt of the IRS summons. United States v. Administration Co., 74 AFTR 2d 94-5252, 94-2 USTC par. 50,479 (N.D. Ill. 1994). In addition, the District Court went on to conclude that Kanter acted in bad faith inasmuch as he first promised to produce the documents sought from TACI, PSAC, THC, and other Kanter-related entities and then abruptly asserted in early February 1994 that the entities in question were third parties over whom he had no control. Id. at 94-5254, 94-2 USTC par. 50,479, at 85,769.

Less than a month later, the same District Court judge held Gallenberger in contempt for a continuing failure to comply fully with the IRS summonses. United States v. Administration Co., 74 AFTR 2d 94-5256, 94-2 USTC par. 50,480 (N.D. Ill. 1994). Gallenberger's contempt citation was affirmed on appeal. See United States v. Administrative Enters., 46 F.3d 670 (7th Cir. 1995).

We infer from all the facts and circumstances that Ballard agreed with Kanter's strategy of obfuscation and delay in a deliberate effort to hinder respondent's efforts in these cases.

I. Conclusion

In the light of all these factors, we conclude respondent has demonstrated by clear and convincing evidence that Kanter and Ballard filed false and fraudulent tax returns for each of years at issue. Specifically, we sustain respondent's determinations that (1) Kanter's underpayments for 1978 to 1984 and 1986 to 1989, attributable to payments from The Five, were due to fraud with intent to evade tax, and (2) Ballard's underpayments for 1978 to 1982, 1984, and 1987 to 1989, attributable to payments from The Five, were due to fraud with intent to evade tax. Consequently, Kanter and Ballard are liable for additions to tax for fraud as asserted in respondent's amended pleadings.¹²⁵

Consistent with the foregoing, we reject Kanter's and Ballard's assertions that the period of limitations governing assessment and collection has expired for some of the years at issue. In short, the period of limitations remains open for each of years at issue pursuant to section 6501(c)(1) which provides that tax may be assessed at any time in the case of a false and fraudulent tax return with the intent to evade tax.

Issue III. Whether Commitment Fees Paid to Century Industries, Ltd., During 1981 to 1984 and 1986 Are Includable in Kanter's Income (STJ report at 86-92)¹²⁶

Century Industries was a partnership organized in 1979, and its partners were the Bea Ritch Trusts, Solomon Weisgal (individually and for his own account, rather than as trustee of the Bea Ritch trusts), and Earl Chapman. The 25 Bea Ritch Trusts (collectively), Weisgal, and Chapman each held one-third interests in the partnership. The partnership's objective was to engage in highly leveraged investments in which the partners would contribute relatively minimal amounts of their own capital. The partnership was ultimately unsuccessful in such investments.

In early 1980, the partnership was reconstituted. Chapman withdrew from the partnership, new partners were admitted, and the partnership's investment focus was changed. The reconstituted partnership purportedly would engage in investments in which its partners would be required to contribute larger amounts of capital. The new partners included Kanter, four family trusts for the benefit of Weisgal's family members (James Children's Trust, Lawrence Children's Trust, Lee Children's Trust, and Richard Children's Trust), and Atlay Valley Investments General Partnership (Atlay Partnership), another investment partnership composed of irrevocable trusts for the benefit of Mr. Weisgal's family. During 1980 and 1981, the partners in Century Industries, their capital interests, and their initial capital contributions were as follows:

 Partner                     Partnership Int.     Capital Contrib.

Century Industries had no office or employees of its own and operated out of Weisgal's accounting firm offices. After 1981, its partners did not make additional capital contributions until sometime in 1986. During 1986 and 1987, its partners made the following additional capital contributions:

                              1986 Capital         1987 Capital

 Payer                   1981       1982     1983     1984      1985     1986

On February 1, 1984, Century Industries sent an invoice to datcorp for $100,000 for "Consultation, analysis, & recommendations regarding financial advice and structuring in connection with investment placement opportunities". Exh. 9243, at 2. On September 12, 1984, Satcorp and Century Industries (by Weisgal), executed a letter agreement which stated in pertinent part:

On November 20, 1984, Weisgal sent an invoice on behalf of Century Industries to City & Suburban Distributors, Inc. (C&S), in the amount of $6,000, for special tax and consulting services through October 31, 1984. Exh. 9244, at 8, 10. A letter accompanying the invoice stated:

From 1983 through 1986, Kanter and Weisgal received the following guaranteed payments from Century Industries:

 Year           Kanter          Weisgal

Century Industries filed Forms 1065 (U.S. Partnership Returns) for 1980 through 1986 which demonstrate that Century Industries made only a relatively small number of investments and incurred minimal expenses during that period. On these returns, the partnership reported the following items of income and expenses:

 Payer             1980      1981      1982     1983     1984     1985     1986

In notices of deficiency issued to the Kanters for 1981 to 1984 and 1986, respondent determined that Century Industries income for those years constituted Kanter's income. On brief, respondent asserted that for 1981 through 1984 and 1986, Kanter is taxable on 50 percent of the ordinary income reported by Century Industries plus any guaranteed payments he received during those years. Respondent's Opening Brief at 796.

Respondent issued a notice of final partnership administrative adjustment (FPAA) to Century Industries reallocating some of the partnership's 1986 income to Kanter. No FPAA was issued to Century Industries for 1983 and 1984. In effect, respondent disregarded all of the other partners in Century Industries except Kanter and Weisgal.

Respondent asserts that, for tax purposes, Kanter and Weisgal are the only two persons who should be recognized as partners in Century Industries and each should be treated as owning a 50-percent interest. Respondent asserts that, until 1987, the other purported partners' interests in Century Industries were shams, as the ostensible partnership between them and Kanter and Weisgal existed only to shift income Kanter and Weisgal earned, i.e., the fees paid to Century Industries, to their family trusts -- the other purported partners.

Respondent further maintains the Court has subject matter jurisdiction over the 1983, 1984, and 1986 adjustments to Kanter's taxable income from Century Industries because the only persons to be recognized as Century Industries partners for tax purposes are Kanter and Weisgal, and, therefore, the partnership is a small partnership specifically excepted from the TEFRA partnership provisions.

Section 6231(a)(1)(A) defines the term "partnership" and identifies the partnerships that are subject to the TEFRA partnership provisions. Section 6231(a)(1)(B), in general, excludes "small partnerships" from the section 6231(a)(1)(A) definition of "partnership".¹²⁸ A small partnership generally is a partnership (1) that has 10 or fewer partners, (2) all of whose partners are either estates or natural persons who are U.S. citizens or resident aliens, and (3) where each partner's share of each partnership item is the same as the partner's share of every other partnership item. Sec. 6231(a)(1)(B)(i); sec. 301.6231(a)(1)- 1T(a)(1) through (3), Temporary. Proced. & Admin. Regs., 52 Fed. Reg. 6789 (Mar. 5, 1987). A determination of whether a partnership qualifies as a small partnership is to be made for each of the partnership's taxable years. Sec. 301.6231(a)(1)-1T(a)(4), Temporary. Proced. & Admin. Regs., 52 Fed. Reg. 6789 (Mar. 5, 1987).

After Culbertson, Congress enacted statutory provisions to address the recognition of partners in family partnerships in which capital is a material income-producing factor. Specifically, section 704(e)(1) provides, as to partnerships in which capital is a material income-producing factor, that a person owning a capital interest in such a partnership must be recognized as a partner, whether that person's capital interest was acquired by purchase or gift. However, if appropriate, partnership income (otherwise allocable to the donee of a partnership interest) can be reallocated to ensure that the donor of a partnership interest receives reasonable compensation for services the donor renders to the partnership. Sec. 704(e)(2); sec. 1.704-1(e)(3), Income Tax Regs. For purposes of section 704(e)(1), the determination of whether capital is a material income-producing factor must be made with reference to all of the facts presented in the particular case.¹²⁹

As discussed in greater detail below, we agree with respondent that, other than Kanter and Weisgal, Century Industries' purported partners are not to be recognized as partners during the period 1981 to 1986 because they did not intend to conduct a business enterprise. The contrary recommended holding in the STJ report was manifestly unreasonable. Inasmuch as Kanter and Weisgal were the only partners of Century Industries recognizable for Federal income tax purposes, and Century Industries did not file an election under section 6231(a)(1)(B)(ii) to have the exception for small partnerships not apply, it follows that Century Industries was a small partnership, within the meaning of section 6231(a)(1)(B), to which the TEFRA partnership procedures do not apply. Consequently, we hold the Court has jurisdiction in these deficiency cases to determine whether half of the payments to Century Industries during 1983, 1984, and 1986 represent income earned by Kanter.

The record shows that, other than Kanter and Weisgal, Century Industries' purported partners rendered no services and contributed only insignificant amounts of capital to the partnership during the years at issue. Moreover, capital was not a material income- producing factor for Century Industries during 1981 to 1986. No funds of any significance were collected from the alleged partners until 1986, and most of Century Industries' income during the period 1981 to 1986 consisted of fees and commissions. Although Kanter asserted that the partnership was formed as an investment vehicle, the partnership did not make any significant investments during the period 1981 to 1986. During the same period, Kanter and Weisgal provided professional services for Silite, Satcorp, C&S, and others and arranged for the payments for those services to be remitted to Century Industries. Thus, insofar as Century Industries is respected as a partnership for the years in question, the partnership was limited to Kanter and Weisgal, and, therefore, Kanter is taxable on a one-half distributive share of Century Industries' income.

Petitioners aver that Century Industries earned the fees in question as compensation for evaluating whether it would make certain investments. There is no direct evidence to support this assertion. To the contrary, the objective evidence of record demonstrates that the fees paid to Century Industries represented compensation to Kanter and Weisgal for services they provided to the payors, and those services were unrelated to any potential investment by Century Industries. For example, a September 12, 1984, letter from Century Industries to Satcorp stated (1) Kanter and Weisgal would serve as so-called financial engineers for Satcorp and Kanter and Weisgal would be principally involved in planning and structuring transactions for financing for Satcorp, its operating companies, and its future projects, and (2) Century Industries would consider participating in the actual process of obtaining financing, but it "will not be routinely responsible for any such activities." Similarly, letters from Weisgal to C&S in late 1984 revealed that Century Industries billed C&S for services provided by Kanter and Weisgal including financial planning, consideration of leverage debt financing, consideration and evaluation of debt financing coupled with additional equity, review and identification of sources of bank financing, conference with lenders, review identification of potential equity sources, and various meetings and updates with Angelo and John Geocaris.

In sum, the record shows that Kanter and Weisgal were billing C&S at some sort of hourly rate, the services provided to Satcorp and C&S related to an evaluation of various forms and sources of debt financing those companies might pursue, and there was no mention in these letters that Century Industries was considering investing its own funds in any of the enterprises.

Weighing the overwhelming objective evidence summarized above against Kanter's and Weisgal's testimony, we conclude the testimony was inherently implausible and not credible, and the STJ report was manifestly unreasonable in accepting that testimony in the light of the documentary record in these cases. We hold that one-half of Century Industries income during 1981 to 1984 and 1986 is income taxable to Kanter for those years.

Issue IV. Whether Kanter Received Unreported Income From Hi- Chicago Trust During 1981 to 1983 (STJ report at 106- 111)¹³⁰

Respondent determined that payments of $42,720, $19,247, and $109,399 Hi-Chicago Trust made to THC during 1981, 1982, and 1983, respectively, constituted income earned by Kanter. The parties filed with the Court a stipulation of settled issues in which Kanter conceded the adjustment for the taxable year 1981. The parties disagree whether the payments Hi-Chicago Trust made to THC during 1982 and 1983 represent Kanter's income.

From Hi-Chicago Trust's inception in 1972 through at least 1989, Kanter was trustee for the trust. The trust instrument grants to the trustee broad powers with respect to making investments on the trust's behalf.

At the time of the trust's creation, Kanter, Federman, and the trust's beneficiaries orally agreed Kanter or Kanter's designee generally would have: (1) The right to receive payment of an amount equal to 10 percent of any gains the trust realized upon the sale or disposition of a trust investment, and (2) an option to obtain from the trust a 10-percent portion of any trust investment property upon payment to the trust of 10 percent of the trust's cost for that investment property. In the event the foregoing option was exercised, the trust would distribute in-kind to Kanter or Kanter's designee a 10-percent portion of that property. These payment obligations and option rights were to last as long as the trust remained in existence. Pursuant to the above arrangement between Kanter, Federman, and the trust's beneficiaries, during 1980 through 1983, Hi-Chicago Trust paid THCthe following amounts on or about the dates indicated:

 Date                              Payment

Respondent, on the other hand, contends that under the assignment of income doctrine, the payments were taxable compensation for Kanter's personal services.

Kanter's testimony on this point is self-serving and unconvincing. In effect, petitioners assert Federman and the trust beneficiaries, in agreeing to the 1972 arrangement, made a "gift" to Kanter. However, the Court does not believe Federman and the trust beneficiaries were acting out of a "detached and disinterested generosity" to Kanter. See Commissioner v. Duberstein, 363 U.S. 278, 285-286 (1960). Undoubtedly Federman and the trust beneficiaries were eager to have Kanter serve as trustee and manage the trust's investments inasmuch as Kanter had extensive business contacts and he offered the promise of lucrative returns on the trust's investments. Such profitable trust investments could greatly benefit the trust's beneficiaries. The "carried interest" provided a direct financial incentive to Kanter, as trustee and manager, to seek out and make profitable investments on behalf of Hi-Chicago Trust.¹³¹

In addition, as respondent points out, the compensatory nature of the arrangement is confirmed by the trust's tax treatment of the payments to THC. The 1981 payment the trust made to THC was deducted as a trustee's fee, and the 1982 payment was specifically characterized on the trust's return as a "commission". Indeed, Kanter, as trustee, signed all the trust's returns. Although Kanter, in his testimony, denied that the trust's payments were compensation to him, he did not describe what, if any, specific services THC had performed in exchange for the trust's payments. Kanter also offered no evidence regarding the terms and conditions of his purported assignment of the "carried interest" to THC.

The Court concludes the payments from Hi-Chicago Trust to THC represented compensation to Kanter for his personal services, and, as such, those payments are includable in Kanter's taxable income for 1982 and 1983 under the assignment of income doctrine.¹³²

Issue V. Whether Kanter Is Taxable on Income Attributed to the Bea Ritch Trusts for 1986 and 1987 (STJ report at 111- 121)¹³³

At some unknown point before 1987, 60 trusts (the various JSK Trusts) were added as beneficiaries of the Bea Ritch Trusts. Exhs. 135, 9187, 9269, 9270, 9271. The original and additional beneficiaries of each of the Bea Ritch Trusts are set forth in detail in appendix 17. Kanter was the trustee for each of the 60 additional trusts which became the beneficiaries of the Bea Ritch Trusts. Exhs. 9187, 9269, 9270, 9271.

No evidence was introduced at trial as to terms of, or the identity of the beneficiaries of, the 60 additional trusts that became beneficiaries of the Bea Ritch Trusts. No evidence was introduced at trial as to how the 60 trusts were appointed beneficiaries of the Bea Ritch Trusts.

As of January 1, 1987, the Bea Ritch Trusts possessed substantial assets and financial net worth. Since their inception, each of the 25 trusts filed Federal income tax returns for the fiscal year ending September 30. On their returns covering the period 1969 to 1986, the trusts, collectively, reported substantial income, deductions, and losses from numerous investments. These investments included the trusts' ownership of all of IRA's outstanding stock, their ownership of substantial stock interests in THC, and their acquisition in 1973 of a collective 18-percent interest in the Oyster Bay Associates Partnership that invested in a cable television venture.

On September 1, 1973, a number of Levenfeld/Kanter's partners joined in forming a partnership known as Oyster Bay Associates (OBA). Statland Exh. 2; Statland, Baskes Transcr. on 5/27/87 (PM) (hereinafter Baskes Transcr.) at 6-13. OBA's partners included Levenfeld/Kanter partners, entities owned by Levenfeld/Kanter partners, or members of their families. Id. Each Levenfeld/Kanter partner or his family entity that became a partner of OBA shared in the profits and losses of OBA in the same percentage in which the partner shared in the profits and losses of Levenfeld/Kanter in 1973. Baskes Transcr. at 12-13. The partners contributed to OBA total capital of $100,000. Statland Exh. 14. During 1974, OBA's partners received distributions greater than their 1973 capital contributions to OBA. Statland Exh. 14.

Kanter chose to participate in OBA. Statland Exh. 2; Baskes Transcr. at 7-13. Kanter could have participated personally in OBA but designated the Bea Ritch Trusts to participate in OBA up to his 18-percent interest in Levenfeld/Kanter. Id. The Bea Ritch Trusts acquired an 18-percent partnership interest in OBA and contributed $18,000 to OBA. Statland Exhs. 2, 14. During 1974, the Bea Ritch Trusts received distributions from OBA greater than the capital contributions of $18,000 they made to the partnership in 1973. Statland Exh. 14.

On September 1, 1973 (the same day OBA was formed), an Illinois general partnership, Long Island Cable Communications Development Co. (Long Island Cable), was formed. Statland Exh. 2B. Long Island Cable's partners included class A partners and one class B partner, OBA. Id. The Long Island Cable partnership agreement stated the partnership was formed to negotiate for the purchase of certain existing franchise rights and equipment collectively constituting a cable television system in Nassau County, New York, and thereafter to operate those franchise rights by the construction of additional cable communication facilities and marketing those facilities in New York and/or Illinois. Id.

Long Island Cable's class A partners, their percentage interests, and their capital contributions were as follows:

 Partner             Percentage     Capital Contributed

Long Island Cable's partnership agreement provided that OBA (the class B partner) agreed to contribute or secure additional partners to contribute all additional cash required to advance the business of Long Island Cable. Id. at 2. The Long Island Cable partnership agreement also provided that the profits and losses of Long Island Cable were to be shared by the class A partners in their respective partnership percentage interests until January 1, 1977, or the first date the class B partner, OBA, was called upon to contribute capital to Long Island Cable, whichever date occurred earlier, and thereafter the profits and losses were to be shared seven-eighths by the class A partners and one-eighth by the class B partner, OBA. Id. at 2-3.

On January 25, 1974, a New York limited partnership, Long Island Cable Communications Development Co. (LICCDC), was formed. Statland Exh. 3A. LICCDC's general partners were Communications Development Long Island Corp., a New York corporation (CDLIC), Communications Management Corp., a Delaware corporation (CMC), and Charles F. Dolan (Dolan). Id. at 1-2. OBA owned all of the stock of CMC. Exh. 7319 (next to last page). Kanter was the president and Baskes was the vice president of CMC. Id.

LICCDC's limited partners included class A and class B participants. Statland Exh. 3A, at 4. The class A participants consisted of various persons who contributed to the partnership cash of $1,015,000 and $485,000 in 1974 and 1975, respectively. Statland Exh. 3, at 3-4. The class B participants consisted of OBA and Eagle Ventures, Inc. (EV). Id. at 4.

The LICCDC partnership agreement provided that LICCDC was formed to carry on the business of constructing, owning, altering, repairing, financing, operating, promoting, and otherwise exploiting one or more cable television systems in Nassau and Suffolk Counties in the State of New York. Statland Exh. 3A, at 2. The LICCDC partnership agreement stated:

The LICCDC partnership agreement provided that profits and losses would be shared as follows: 99 percent by the class A participants and 1 percent by Dolan until January 1, 1977; if payout had not occurred by January 1, 1977, then 5.5 percent to Dolan and CDLIC, 83.5 percent to class A participants, and 11 percent to class B participants, respectively, until payout occurred; and after payout (or after January 1, 1977, if it had occurred by then, 64 percent to Dolan and CDLIC, 1 percent to CMC, 22.5 percent to class A participants, and 12.5 percent to class B participants, respectively. Statland Exh. 3A, at 6-7. Payout was defined to occur on the date on which the cumulative cashflow, which was to have been distributed to the partners since the inception of the partnership, equaled or exceeded $1,500,000. Id. at 7.

Class C and D interests in LICCDC were created by an amendment to the LICCDC partnership agreement on January 1, 1975. Statland Exh. 4. On the same day, Dolan and OBA formed the Hempstead-Babylon Partnership (HB) to acquire the class C and D interests. Statland Exh. 5. Within 10 days, on January 10, 1975, the class C interests were sold to Nassau/Suffolk Cablevision Investors for $4,500,000. Statland Exh. 5B.

Levenfeld/Kanter's law firm partners sometimes raised capital for investments and businesses owned by the firm's clients. Statland Exh. 23. Kanter and other Levenfeld/Kanter partners participating in OBA solicited and obtained from various investors the funds OBA promised to contribute to LICCDC. Kanter, Transcr. at 4591, 4681-4684; Exhs. 7312, 7313, 7315-7318; Statland Exhs. 6, 22-24, 26; Statland Exh. 53 (Dolan Deposition), at 69-71, 129, 130, 138, 165, 179, 194; Baskes Transcr. at 37-41. Kanter personally solicited investors for LICCDC including, but not limited to, Genesis Ventures and Hugh Hefner. Exhs. 7310, 7311; Kanter, Transcr. at 4683-4684. As a result of the funds raised by Kanter and other Levenfeld/Kanter partners for LICCDC, OBA never contributed more than $2,000 in cash or property to LICCDC. Statland Exhs. 12, 16-19; Baskes Transcr. at 33-34.

In exchange for the funds Kanter and other Levenfeld/Kanter partners raised for LICCDC, OBA received its interest in LICCDC and additional interests in LICCDC through additional partnerships including HB, Bergen-Westchester (BW), and Yorkshire Partners (YP) for which OBA paid no cash or other property. Statland Exhs. 5, 10; Exh. 7307; Statland Exhs. 12, 16-19; Baskes Transcr. at 33-34; Statland Exh. 53 (Dolan Deposition), at 71.

As of June 13, 1978, LICCDC changed its name to Cablevision Systems Development Co. (Cablevision). Statland, Exh. 20.

In about 1984, one of Kanter's former law partners, Donald Statland, commenced an action in Illinois State court against Kanter and other Levenfeld/Kanter partners in an action captioned Statland v. Levenfeld, et al., No. 84 CH 6494 (the Statland case), concerning their involvement in Cablevision. Statland alleged, among other things, that the Levenfeld/Kanter partners, in substantial part, had obtained their and/or their families' Oyster Bay Associates partnership interests in exchange for the law firm's services and the law partners' efforts to recruit unrelated, third-party investors. Statland claimed he was entitled to a share of the Oyster Bay Associates partnership interests because those partnership interests represented law firm partnership income. Ultimately, the Illinois State court ruled against Statland and held, among other things, that Statland was not entitled to a share of the Oyster Bay Associates partnership interests.

The Bea Ritch Trusts' tax returns for the fiscal year ended September 30, 1987, included aggregate net long-term capital gains from the HB, BW, and YB partnerships of $1,143,248, $274,660 and $615,460, respectively. Exh 9186. HB, BW, and YP recognized these capital gains when they sold (during 1986) interests in LICCDC/Cablevision. Exhs. 9186, HB, BW and YP Schedules K-1; 7307. As discussed above, the Bea Ritch Trusts acquired their HB, BW, and YP partnership interests indirectly through their partnership interests in OBA. Exh. 9186, HB, BW and YP Schedules K-1.

Over the years, the Bea Ritch Trusts made substantial loans to Kanter. TACI's general ledger reflects that Kanter borrowed $150,000 from the Bea Ritch Trusts during 1986 and repaid $10,000 to the trusts during that year. Exh. 9110 (ledger tab). As of January 1, 1987, Kanter owed a total of $287,030 to the Bea Ritch Trusts.¹³⁵ As of January 1, 1989, Kanter owed the trusts $1,311,430 as a result of additional loans from the trusts. Kanter also borrowed substantial sums from IRA and THC during the period 1987 to 1989. Exhs. 9110 (TACI ledger for 1986), 9111 (Kanter ledger for 1987, Bates No. 000106), 9114.

Respondent determined in the notice of deficiency issued to the Kanters for 1987 that the Bea Ritch Trusts were Kanter's grantor trusts under section 671. Respondent further determined that, as such, all or portions of the following items constituted taxable income, losses, or deductions of Kanter: (1) $1,094,896 of the trusts' gross receipts; (2) $295,298 of the trusts' interest income; (3) dividend income of $325; (4) passive activity partnership losses totaling $261,040; (5) $3,094,058 of net capital gain income;¹³⁶ and (6) certain investment interest expenses.

In applying the grantor trust rules described above, the principle of substance over form is particularly applicable considering the potential for manipulation of trusts. See Zmuda v. Commissioner, 79 T.C. 714 (1982), affd. 731 F.2d 1417 (9th Cir. 1984); Lazarus v. Commissioner, 58 T.C. 854, 864 (1972), affd. 513 F.2d 824 (9th Cir. 1975). The grantor of a trust may be the person who actually funded the trust as opposed to the person named as the grantor in the trust instrument. United States v. Buttorff, 761 F.2d 1056, 1060-1061 (5th Cir. 1985); Schulz v. Commissioner, 686 F.2d 490, 496 (7th Cir. 1982), affg. T.C. Memo. 1980-568. In Schulz, for example, the taxpayer's wife was considered the grantor of a family trust because the conveyance of the wife's assets to her husband (which were used to fund the trust) was disregarded.

Respondent, on the other hand, advances a number of arguments in contending the 1986 and 1987 adjustments to Kanter's income should be sustained. Respondent contends Kanter is the true settlor of the Bea Ritch Trusts as evidenced by the substantial amounts he transferred to or for the benefit of the trusts over the years including (1) his share of payments from The Five to IRA and THC (discussed supra, Issue I) in which the Bea Ritch Trusts held substantial stock interests), (2) Kanter's share of fees paid to Century Industries during 1981 to 1984 and 1986 (discussed supra, Issue III), with regard to which the trusts ostensibly held a 49-percent partnership interest, (3) the fees Kanter earned during 1981 to 1983 from Hi-Chicago Trust which Kanter attempted to assign to THC (discussed supra Issue IV) in which the trusts held substantial stock interests, and (4) the 18-percent partnership interest the trusts acquired in OBA. Respondent also asserts that sections 674(a) and 675(3) apply under the facts presented so as to attribute to Kanter all of the trusts' income for 1986 and 1987.

As discussed below, the objective evidence of record indicates Kanter transferred substantial sums of his own income to the Bea Ritch Trusts (directly and through IRA and THC) and Kanter (through the Bea Ritch Trusts) was compensated with partnership interests in LICCDC/Cablevision in exchange for recruiting investors for the Cablevision project. Viewed in the light of the entire record, the credibility determinations and recommended holding in the STJ report were manifestly unreasonable.

We have already determined Kanter employed IRA and THC as shams to receive, and shelter from taxation, income which Kanter personally earned from a variety of transactions. Kanter attempted to assign to IRA and THC substantial amounts of income which he earned in the form of payments from The Five. The Bea Ritch Trusts owned all of IRA's common stock, and they held a substantial interest in THC.

Similarly, we conclude Kanter attempted to assign to Century Industries (in which the Bea Ritch Trusts purportedly held a 49-percent partnership interest) fees he earned evaluating investment opportunities for various third parties. Kanter employed the same tactics in attempting to improperly assign to THC substantial fees he earned serving as trustee/investment manager for Hi-Chicago Trust. Thus, during the period 1977 to 1989, the record reflects Kanter engaged in an active and sustained campaign to transfer his income to IRA, THC, and other Kanter-related entities for the ultimate benefit of the Bea Ritch Trusts. We conclude Kanter is the grantor of the Bea Ritch Trusts.

In connection with the foregoing, Kanter failed to offer any rational explanation for the addition of 60 trusts as beneficiaries of the Bea Ritch Trusts after Kanter purportedly renounced his interests in those trusts. Kanter was the only person vested with the power under the instrument creating the Bea Ritch Trusts to appoint new trust beneficiaries. Under the circumstances, we infer Kanter appointed the new beneficiaries and his earlier renunciations were, for all practical purposes, meaningless gestures.

In sum, we hold Kanter was the true settlor of the Bea Ritch Trusts -- he funded the trusts over a period of many years, and he retained at all times a power to appoint the beneficiaries of the Bea Ritch Trusts that was tantamount to a power of disposition over the trusts' assets. See secs. 671, 674(a); sec. 1.6712(e)(1), Income Tax Regs. ("[A] grantor includes any person to the extent such person either creates a trust, or directly or indirectly makes a gratuitous transfer * * * of property to a trust. * * * If a person creates or funds a trust on behalf of another person, both persons are treated as grantors of the trust."); sec. 1.674(a)-1, Income Tax Regs. Consequently, Kanter is taxable on the income of the Bea Ritch Trusts for 1986 and 1987.¹³⁷

The Cablevision transactions in 1986 and 1987 were additional examples of Kanter's preferred modus operandi. In particular, Kanter allowed the Bea Ritch Trusts to subscribe to the 18-percent partnership interest in OBA to which he was otherwise entitled. Although the Bea Ritch Trusts invested $18,000 in OBA, as discussed above, those funds in all likelihood derived from earnings Kanter assigned to or for the benefit of the trusts. Moreover, the record shows that OBA received its interest in LICCDC/Cablevision and the additional related partnership interests in HB, BW, and YP solely in exchange for Kanter's and other Levenfeld/Kanter partners' efforts to raise capital for LICCDC/Cablevision. Thus, the Bea Ritch Trusts' partnership interests in HB, BW, and YP (acquired through OBA) represented nothing more than Kanter's compensation for recruiting additional investors for the Cablevision project.¹³⁸ Once again, Kanter improperly attempted to assign to the Bea Ritch Trusts income he earned as payments for his personal services. Accordingly, we hold Kanter, as grantor of the Bea Ritch Trusts, is taxable on the trusts' income for 1986 and 1987.

Issue VI. Whether Kanter Received Unreported Income From CMS Investors Partnership for 1982 to 1984 and 1987 to 1989 (STJ report at 121-129)¹³⁹

Much as in the Cablevision transaction (discussed supra Issue V), members of the Levenfeld/Kanter law partnership and/or entities established for the benefit of their families were offered and acquired partnership interests in CMS Investors during 1978. Kanter, Transcr. at 4105-4107; Exh. 9134. Kanter permitted THC to invest in his share of the CMS Investors offering. Kanter, Transcr. at 4198-4199.

Delta Partnership (Delta) was formed on the same date that CMS Investors was formed and CMS Investors acquired a 95.5percent partnership interest in Delta. Exh. 9135. Alpha Partnership (Alpha) was formed in May 1979, and CMS Investors acquired an 85.5-percent partnership interest in Alpha. Exh. 9136.

In 1978, Delta made a substantial loan to another partnership, Shelburne Associates (Shelburne), which the latter used to purchase several feature-length motion pictures. Exh. 9137. In 1979, Alpha made a substantial loan to another partnership, Century Associates (Century), which the latter used to purchase several feature-length motion pictures. Exh. 9138.

Respondent concedes Shelburne and Century both paid substantial legal fees to the Levenfeld/Kanter law firm. Respondent's Opening Brief at 920, par. 1382.

Shelburne and Century subsequently transferred to Delta and Alpha substantial amounts, characterized as bonus payments, and CMS Investors received distributable shares of these bonus payments as a partner in Delta and Alpha. THC, a CMS Investors partner, in turn received its distributable share of the bonus payments. THC reported these payments as income on its income tax returns. As indicated, respondent determined that THC's share of the Shelburne and Century bonus payments represented Kanter's income.

This Court, in Durkin v. Commissioner, 87 T.C. 1329 (1986), affd. 872 F.2d 1271 (7th Cir. 1989), passed upon and made certain factual conclusions regarding the loan by Delta to Shelburne under which loan one of the bonus payments in dispute in these case was made. Under the terms of both loans, Shelburne and Century, as the debtors, were required not only to pay principal and interest to Delta and Alpha, but Shelburne and Century were also required, under certain conditions, to pay Delta and Alpha certain amounts referred to as bonus payments. These bonus payments were in fact paid, and both Shelburne and Century treated these bonus payments as interest and claimed deductions of such payments for income tax purposes. In Durkin v. Commissioner, supra, this Court held the Shelburne bonus payment did not constitute compensation for the use of money and, therefore, it was not deductible as interest. The Court further held the bonus payment essentially was nothing more than a mechanism to divert funds from Shelburne to Delta (and on to CMS Investors), "thereby increasing the income of the partnerships and trusts associated with or established for the benefit of the members of the law firm or their immediate families." Durkin v. Commissioner, supra at 1400.

The parties here do not dispute the factual findings or the holding of the Court in Durkin v. Commissioner, supra. Nor do the parties deny that the bonus payments constitute income to the recipient partnerships.

On brief, respondent acknowledges Durkin did not address the question whether the family entities or the Levenfeld/Kanter law partners, individually, were taxable on the bonus payment paid by Shelburne to Delta. Respondent nevertheless argues Kanter is taxable on the share of the bonus payments paid by Shelburne and Century to Alpha and Delta, respectively, that flowed through CMS Investors to THC.

Respondent maintains that the portions of the bonus payments that eventually made their way to THC represent income taxable to Kanter under the assignment of income doctrine. See Lucas v. Earl, 281 U.S. 111 (1930). Respondent argues (1) the bonus payments were not paid for the use of funds but were used as a means to divert funds from Shelburne and Century to CMS Investors' partners, and (2) the bonus payments represented income earned by the individual partners of the Levenfeld/Kanter law partnership "through their actions in creating the right to receive the bonus payments and diverting them to their respective family entities." Respondent's Opening Brief at 927.

Respondent's position apparently is based on the Court's finding in Durkin v. Commissioner, supra, that the Shelburne bonus payment to Delta was not made for the use of money but was a mechanism to divert funds to CMS Investors and the various entities established for the benefit of the Levenfeld/Kanter law partners and/or their immediate families. Respondent argues there was no need for the loans to Shelburne and Century because Shelburne and Century would, in due course, realize funds from movie revenues that would alleviate the need for such financing. Therefore, respondent asserts, the loans were structured merely to create purported payments of interest which were, in effect, payments to Kanter and his law firm for legal services the firm provided in connection with movie syndications.

Respondent further asserts that the purpose of diverting the bonus payments to CMS Investors, which flowed through to THC and other Levenfeld/Kanter family entities, was the "improper avoidance of income, gift and estate taxes" because THC had large operating losses and, therefore, paid no income taxes on the bonus payments received.

Pursuant to a longstanding practice, Levenfeld/Kanter's law partners were offered the opportunity to acquire partnership interests in CMS Investors (and indirectly Delta and Alpha). Participation was voluntary, and investments were made by a law firm member, a member's immediate family, and/or a family entity for their own accounts and not on behalf of the law partnership. Some of the law firm partners elected not to participate in the CMS Investors offering. The Levenfeld/Kanter law partnership did not have any interest in or rights to the income from the venture.

Delta's and Alpha's loans to Shelburne and Century were not investment activities of the Levenfeld/Kanter law partnership. The law firm members who participated in these ventures had no intention to invest on the law firm's behalf. More importantly, the alleged diversions of funds from Shelburne and Century (in the form of the bonus payments) were not joint business endeavors of Levenfeld/Kanter's law partners, as only those members of the law firm and/or their families who invested in CMS Investors (and Delta and Alpha) would benefit from the bonus payments.

On the record presented, the Court concludes the bonus payments were not income attributable to the Levenfeld/Kanter law partnership. Consequently, the Court has subject matter jurisdiction over the CMS Investors income adjustments at issue in the instant deficiency cases inasmuch as they do not constitute partnership items within the meaning of section 6231(a)(3).¹⁴¹

In Durkin v. Commissioner, supra at 1399-1401, the Court held that the Shelburne bonus payment did not constitute interest and, therefore, it was not deductible. The Court also suggested the Shelburne bonus payment was simply a distribution of profits from Shelburne to CMS Investors disguised as an interest payment. Id. at 1400. From these points, respondent infers that the loans giving rise to the bonus payments were, in effect, loans made by Kanter and his law partners. Respondent goes well beyond the holding of Durkin. The Court in Durkin made no such finding, and respondent has misinterpreted the case.

We reject the argument that Kanter attempted to assign to THC the income from the bonus payments. Although we have concluded Kanter used THC as a conduit to receive his share of some of the payments from The Five, as well as income that he earned providing services to Hi-Chicago Trust, this transaction does not fit that mold. The payments to THC from The Five and Hi-Chicago Trust represented compensation to Kanter for personal services. Here, however, there is no evidence Kanter provided any personal services or assistance to CMS Investors, Alpha, Delta, Shelburne, or Century. Rather, Delta and Alpha made bona fide loans to Shelburne and Century. Under the circumstance, we see no justification for concluding that THC served as Kanter's alter ego for purposes of this transaction. Without more, THC's distributive share of CMS Investors' partnership items must be respected. Accordingly, we hold Kanter is not taxable on the income which flowed through CMS Investors to THC for the taxable years 1982, 1983, 1984.¹⁴²

ISSUE VII. Whether Kanter Received Unreported Income From Equitable Leasing Co., Inc., During 1983 (STJ report at 128-129)

Joel Mallin (Mallin) was a good friend and former law partner of Kanter who organized and promoted various equipment leasing transactions through Equity Leasing, his wholly owned company. Kanter, Transcr. at 4749; Mallin, Transcr. at 51725175. Mallin's leasing transactions were highly leveraged, and the residual value of the leased equipment provided the ostensible paper profit on his investors capital. Mallin, Transcr. at 5175-5186.

During 1983, Kanter allowed Mallin to include Zion as an investor in some of Equitable Leasing's offerings so that the offering would be fully subscribed and could close. Kanter, Transcr. at 4752. During 1983, Kanter also introduced additional investors to Mallin so that Equitable Leasing could complete certain transactions. Kanter, Transcr. at 4753, Mallin, Transcr. at 5213-5215.

During 1983, Equitable Leasing transferred funds totaling at least $635,250 to THC and Zion, as follows:

 DATE        AMOUNT     PAYEE     EXHIBIT

THC's accounting records related to these transactions are inconsistent and contradictory. THC recorded about half of the funds it received from Equitable Leasing as loans and the other half as commissions. Exh. 146, at 2, 6 (AJE's 8 and 32); Exh. 148, at 12 (listing loans of $8,000 and $302,000 on June 27 and 30, 1983, respectively). However, THC's records also include an adjusting journal entry for $310,000 (which probably includes the $302,000 transferred to THC on June 30, 1983, and the $8,000 listed as a loan on June 27, 1983, see Exh. 148, at 12) and which appears to read: "N/P-Equitable Leasing, Commission Income, to reclassify funds from Eq. Leasing [date illegible]." Exh. 146, at 11 (AJE 59).

Mallin paid commissions to Kanter (through payments to THC and Zion) in exchange for Kanter's assistance in recruiting investors for his leasing transactions. Kanter, Transcr. at 4753; Mallin, Transcr. at 5213-5214.

Respondent contends all the moneys Equitable Leasing transferred to THC and Zion were commissions paid to Kanter to compensate him for recruiting investors for Mallin's equipment leasing transactions. Kanter argues the funds in question were loans. We agree with respondent.

The record shows: (1) Kanter recruited investors for Equitable Leasing's transactions, and (2) Mallin/Equitable Leasing paid commissions for these services to Kanter-related entities, THC and Zion. Against this evidence, Kanter offered little in the way of rebuttal. Although THC's accounting records labeled some of the funds it received from Equitable Leasing as loans, those entries were contradicted by other entries labeling the payments as commissions. Kanter did not provide any additional evidence such as promissory notes or proof of principal or interest payments to corroborate THC's records. Given that Kanter controlled the entities involved, we resolve any doubts engendered by the record in respondent's favor. Considering all the circumstances, we sustain respondent's determination that the funds that Equitable Leasing transferred to THC and Zion during 1983 represented income that Kanter earned during 1983 and that he attempted to assign to THC and Zion. These payments are includable in Kanter's income for 1983.

Issue VIII. Whether Kanter Received Unreported Income for 1982 According to the Bank Deposits Method of Income Reconstruction (STJ report at 129-133)

Respondent conceded a portion of the subject adjustment, but maintains Kanter failed to report $1,303,207 of income for 1982 based on the bank deposits from the payors or sources in the amounts listed below:

     Payor Or Source         Funds Received   Characterization

This Court has long accepted the bank deposits method of income reconstruction. Nicholas v. Commissioner, 70 T.C. 1057, 1065 (1978); Estate of Mason v. Commissioner, 64 T.C. 651, 653 (1975), affd. 566 F.2d 2 (6th Cir. 1977). While not conclusive, bank deposits are prima facie evidence of income. Boyett v. Commissioner, 204 F.2d 205 (5th Cir. 1953), affg. a Memorandum Opinion of this Court; Hague Estate v. Commissioner, 132 F.2d 775 (2d Cir. 1943), affg. 45 B.T.A. 104 (1941).

Taxpayers generally bear the burden of proving that the Commissioner's determinations are erroneous; and in the case of a bank deposits analysis, a taxpayer normally must show the deposits came from a nontaxable source. Rule 142(a); Welch v. Helverinq, 290 U.S. 111 (1933).

Respondent contends Kanter has not satisfied his burden of proof under Rule 142(a). Respondent argues the testimony and other evidence petitioners offered should be disregarded as self-serving. Respondent asserts Kanter offered no credible documentation substantiating the nontaxable nature of the $1,303,207 of deposits at issue. Respondent emphasizes that two of the disputed deposits are attributable to funds Kanter received from the TACI Special E and TACI Special Accounts which Kanter purportedly used to disguise payments to himself as loans.

Respondent's determination was not a so-called naked assessment, nor was it arbitrary or excessive. See, e.g., Weimerskirch v. Commissioner, 596 F.2d 358 (9th Cir. 1979), revg. 67 T.C. 672 (1977). Respondent offered ample evidence linking Kanter to income- producing activities during 1982 including his law practice and the fees and commissions Kanter earned from, among others, The Five. Respondent identified four specific deposits that were determined to represent unreported income. Therefore, respondent's determination of unreported income is entitled to the normal presumption of correctness, and there is no basis for shifting to respondent either the burden of proof or the burden of going forward with the evidence. See, e.g., United States v. Esser, 520 F.2d 213, 217 (7th Cir. 1975).

As indicated, the record includes Kanter's check register, Gallenberger's spreadsheets and summaries, and Gallenberger's testimony regarding the methods she used in preparing the Kanters' tax return for 1982. Considering all the circumstances, particularly Kanter's and Gallenberger's misconduct as outlined by the District Court during the summons enforcement proceedings, we conclude it was manifestly unreasonable to conclude Kanter's testimony (if it exists) and Gallenberger's testimony was credible. See United States v. Administration Co., 74 AFTR 2d 94-5252, 94-2 USTC par. 50,479 (N.D. Ill. 1994); United States v. Administration Co., 74 AFTR 2d 94-5256, 94-2 USTC par. 50,480 (N.D. Ill. 1994).

We conclude the evidence Kanter offered on this issue was insufficient to satisfy his burden of proof. Given the large amounts of the deposits in question, not to mention Kanter's experience as a tax attorney, Kanter should have been prepared to offer additional records, such as loan documents, checks reflecting prior investments, checks reflecting principal or interest payments, or other accounting records in support of the proposition that the deposits in question were in fact loans or returns of capital. In the absence of such evidence, we sustain respondent's determination that Kanter failed to report $1,303,207 of income for 1982.

Issue IX. Whether Kanter Received Barter Income From Principal Services Accounting Corp. During 1988 and 1989 (STJ report at 133-135)

Respondent determined in notices of deficiency issued to the Kanters for 1988 and 1989 that Kanter failed to report barter income he received from Principal Services Accounting Corp. (PSAC) during those years. These adjustments were resolved in petitioners' favor, and the decisions entered by the Court at docket Nos. 26918-92 (taxable year 1988) and 25981-93 (taxable year 1989) on September 24, 2001, were not appealed and are otherwise final. See secs. 7481(a)(1), 7483.¹⁴⁶ Consequently, we need not consider this issue.

Issue X. Whether the Kanters Received Unreported Interest Income During 1988 (STJ report at 136-137)

Respondent determined in the notice of deficiency issued to the Kanters for 1988 that the Kanters failed to report interest income they received during 1988. This adjustment was resolved in petitioners' favor, and the decision entered by the Court at docket No. 26918-92 (taxable year 1988) on September 24, 2001, was not appealed and is otherwise final. See secs. 7481(a)(1), 7483.¹⁴⁷ Consequently, we need not consider this issue.

Issue XI. Whether the Kanters Are Entitled to Certain Deductions They Claimed on Schedules A and C for 1986 to 1989 (STJ report at 137-144)

In notices of deficiency issued to the Kanters for 1986 to 1989, respondent disallowed deductions the Kanters claimed on Schedules A and C of their tax returns for those years. These adjustments were resolved in petitioners' favor, and the decisions entered by the Court at docket Nos. 24002-91 (taxable year 1987), 26918-92 (taxable year 1988), and 25981-93 (taxable year 1989) on September 24, 2001, were not appealed and are otherwise final. See secs. 7481(a)(1), 7483.

Respondent does not challenge the ultimate conclusion in the STJ report regarding the Kanters' deductions for the taxable years 1987 to 1989. Respondent, however, does not state whether he objects to the STJ report holding with regard to the Kanters' Schedule A deduction for 1986. Therefore, we shall address the question whether petitioners are entitled to the Schedule A deduction in question for 1986.¹⁴⁸

During the course of the trial, petitioners began offering evidence with respect to the above expenses as well as certain 1982 Schedule C deductions. Counsel for the parties then requested and received a short recess in order to meet and discuss off the record the various evidentiary and legal matters pertaining to these expenses. The Court did not participate in counsels' deliberations.

Immediately following their conference, counsel for the parties advised the Court that: (1) The Kanters were entitled to deduct the 1982 Schedule C expenses, and (2) the 1987, 1988, and 1989 Schedule A and Schedule C expenses the Kanters claimed had been substantiated, except that respondent (a) disputed that the expenses paid out of funds from the TACI and PSAC accounts had been paid by Kanter and (b) questioned whether the Kanters were entitled to deduct expenses with respect to property held in trust. Counsel made no mention as to whether this agreement included the Kanters' 1986 Schedule A deduction for interest expenses. Transcr. at 3957-3960. However, counsel for petitioners expressed to the Court their belief that the parties had narrowed the issues on all of the adjustments that were then being heard by the Court. Counsel for respondent expressed no disagreement with that assertion. Following the colloquy between counsel for the parties and the Court, the trial resumed with respect to the remaining issues as to which the parties were unable to agree: (1) Whether payment of the subject expenses out of the TACI Special E and PSAC Special accounts represented payment by the Kanters, and (2) whether the Kanters were entitled to a deduction for interest payments with respect to property (the Kanters' personal residence) that was titled in a grantor trust in which Kanter was the deemed owner.

During and after the trial, the parties filed several stipulations of settlement. On May 15, 1995, the parties filed a Stipulation Of Settlement As To Certain Issues Between Petitioners Burton W. Kanter, Naomi R. Kanter, * * * [IRA], And Subsidiaries, And Respondent. The May 15, 1995 Stipulation Of Settled Issues listed a number of adjustments contained in the notices of deficiency that the parties had settled, including an "Unreported Fee Income" adjustment for 1986. The 1986 interest expense the Kanters claimed was not listed among these settled issues, nor was there any listing of the other Schedule A and Schedule C expenses identified above for the various years in question.

On this record, we conclude petitioners' 1986 interest expense deduction was included in (but inadvertently omitted from) the agreement of counsel narrowing the issues to be decided by the Court. Bearing in mind that these cases were very complicated, involving numerous issues covering several tax years of several taxpayers, it is easy to understand how one adjustment could easily have been overlooked in counsel's announcement to the Court that the parties had agreed to narrow the issues in dispute. Moreover, respondent failed to qualify or take any exception to petitioners' counsel's representations to the Court regarding the scope of their agreement.

Thus, we are left only with the question whether the funds from the TACI and PSAC accounts used to pay Kanter's expenses were Kanter's funds. As previously discussed, the funds Kanter held in the TACI and PSAC accounts were his funds or funds he borrowed from other TACI or PSAC clients. Accordingly, the Kanters are entitled the interest expense deduction they claimed for 1986.

Issue XII. Whether Kanter Realized and Must Recognize Capital Gains as a Result of Transactions Involving Cashmere Investments Associates, Inc., During 1983 and Whether the Kanters May Use the Installment Method To Report Gains (STJ report at 145)¹⁴⁹

The designated beneficiaries of the BWK Revocable Trust, the BWK Family Trusts, and the Everglades Trusts were members of Kanter's family. Exhs. 453, 583, 9213, 130, 130A; Kanter, Transcr. at 4235, 4261-4262. During 1983, THC's shareholders included Kanter, his immediate family members, and a large number of Kanter family trusts. Exh. 152, at 1, 2, 6, 7; Exh. 454. Weisgal was THC's president. Exh. 9156, item 3.

Kanter's interests in the real estate partnerships are identified below by the entity which held each interest, the partnership, and the entity's percentage interest in the partnership at the beginning of 1983:

                                                       Percentage

During 1982, Zell informed Kanter that Equity Financial Management Co. (Equity), an entity Zell controlled, was interested in purchasing all of the real estate partnership interests listed above. Kanter, Transcr. at 4242-4244, 42534254, 4265, 4302-4303. Although Kanter was interested in selling the partnership interests, he was concerned the transaction would trigger significant capital gains because his grantor trusts had negative capital accounts in the real estate partnership interests; i.e., their liabilities exceeded their bases. Kanter, Transcr. at 4244. Kanter's grantor trusts' negative capital accounts for the partnership interests in question, as of May 15, 1983, totaled $476,888.60, as follows:

    Entity            Partnership/Interest             Cap. Acct.

As of mid-1983, the fair market value of the real estate partnership interests Zell was interested in purchasing totaled $1,219,321.64, as follows:

    Entity          Partnership/Interest       Price (FMV)

Because an unqualified transfer of the partnership interests of the grantor trusts to Zell would involve the assumption of liabilities in excess of the trusts' bases in the partnership interests, Kanter (the owner of those interests by virtue of the grantor trust provisions (sections 671-677) would be required to recognize capital gains on the sale to Zell. In an effort to avoid this result, Kanter directed a series of transactions in 1983 which ultimately resulted in the transfer of both cash and the real estate partnership interests from his grantor trusts to Zell. The transfers took place in three stages described below.

On or about May 15, 1983, Kanter directed the transfer of the grantor trusts' real estate partnership interests to Cashmere in what was intended to be a nontaxable exchange under section 351 in return for Cashmere common and preferred stock. Exh. 9156; Kanter, Transcr. at 4234-4245. THC, the BWK Family Trusts, and the grantor trusts received Cashmere stock in exchange for the real estate partnership interests as follows:

                                   Shares of Stock

Concurrently with the transfers described above, Kanter's grantor trusts also transferred to Cashmere eight promissory notes with an aggregate face value of $498,500. Exh. 9156, item 7; Kanter, Transcr. at 4235-4238, 4244, 4249, 4267-4268. Kanter's grantor trusts transferred the following notes receivable to Cashmere:

        Maker                   Payee                Amount

The trustee of Beach Trust was Albert Morrison, the grantor was Kanter, and the beneficiaries were members of Kanter's family. Exh. 9216. The trustee of the Baroque Trusts was Patricia Grogan, the grantor was Kanter, and the beneficiaries were members of Kanter's family. Exh. 9219. For Federal tax purposes, Kanter was the "deemed owner" of the Baroque Trusts, and income therefrom generally was reportable on Kanter's individual Federal income tax returns. Exh. 9111, Bates Nos. 000125-000127.

Kanter intended that, if the promissory notes were accorded bases equal to face values, the promissory notes would increase the aggregate basis of the property the grantor trusts transferred to Cashmere; i.e, the promissory notes' bases would offset the grantor trusts' negative capital accounts in the real estate partnership interests, thereby eliminating the gain that otherwise would have been realized under section 357(c) if Cashmere had received the real estate partnership interests alone.¹⁵⁰ Kanter did not, however, present any evidence to establish the genuineness of the promissory notes.

On July 12, 1983, the BWK Revocable Trust, the Everglades Trusts, THC, and the BWK Family Trusts sold all of their Cashmere stock (common and preferred shares) to Waco for promissory installment notes totaling approximately $1.5 million. Exh. 9156, items 8, 9. The Waco promissory notes provided for payments in 1983 and 1984 and balloon payments in 1993. Id. The Waco promissory notes were secured by the Cashmere stock, subject to Waco's option to substitute as collateral the guaranties of its shareholders, the Bea Ritch Trusts, which would pledge various partnership interests (known in the aggregate as "Cablevision"). Exh. 9156, item 7, at 3. Sharon Meyers, on behalf of Waco and the Bea Ritch Trusts, subsequently exercised this option to substitute collateral. Exh. 9156, item 46.

Kanter reported installment sale income on Forms 6252 attached to his Federal income tax returns for 1984 and 1985. Exhs. 130, 130A. Kanter did not present any evidence to establish that WACO actually made any payments in connection with the installment promissory notes described above.

On August 25, 1983, Kanter wrote a letter to Lurie which stated that Cashmere's stockholders (at this point Waco and/or the Bea Ritch Trusts) decided they would approve a sale of 100 percent of Cashmere's stock to Equity only in exchange for cash. Exh. 9157. The letter also stated Cashmere held only real estate partnership interests and promissory notes "all of which will be paid down by August 31, 1983." Id.

On August 31, 1983, the promissory notes held by Cashmere were paid off by checks drawn on the TACI Special E account, as follows:

 Ck. No.      Date           Payee              Amount

As of September 1, 1983, Waco held all of Cashmere's outstanding stock, and Cashmere's assets included the real estate partnership interests and $498,500 in cash. Exh. 9156, Item 10(a), at 5.

Zell was not interested in the Cashmere stock and would have preferred to buy the partnership interests outright, but this was the only way that Kanter would permit the sale. Exh. 9157; Kanter, Transcr. at 4250, 4252-4253.

Kanter argues the question whether the Cashmere transaction qualifies for nonrecognition treatment under section 351 is not properly before the Court, and, in any event, the grantor trusts transferred their partnership interests to Cashmere for legitimate business purposes; i.e., to enjoy tax advantages in the event the partnership interests were sold and/or to "have an aggregation of value" within the corporate entity to allow for more efficient investments. Kanter, Transcr. at 4243. Kanter further asserts the section 357(b) issue was not raised in the pleadings and is not properly before the Court and, in any event, the Cashmere transaction is not the type of arrangement that section 357(b) is designed to address. Finally, Kanter contends the promissory notes the grantor trusts transferred to Cashmere constituted genuine indebtedness, rendering section 357(c) inapplicable in these cases.

A taxpayer generally recognizes gain or loss on a sale or exchange of property. Sec. 1001(c). Section 351(a) provides an exception to the general rule of section 1001(c), however, when a taxpayer transfers an appreciated asset (such as a partnership interest) to a controlled corporation solely in exchange for the corporation's stock. The favorable tax benefits associated with section 351 are subject to several qualifying provisions outlined below.

As a general rule, if a taxpayer receives property pursuant to a section 351 exchange and, as part of the transaction, another party to the transaction assumes a liability of the taxpayer, the assumption of liability shall not be treated as the receipt of money or property and shall not disqualify the transaction for nonrecognition treatment under section 351. Sec. 357(a). The general rule of section 357(a) is subject to the two exceptions set forth in section 357(b) and (c).

To paraphrase, section 357(b) provides that an assumption of a taxpayer's liability under section 357(a) shall be considered money received by the taxpayer for purposes of section 351 if, taking into consideration the nature of the liability and the circumstances surrounding the arrangement, it appears the taxpayer's principal purpose was to avoid Federal income tax on the exchange or was not a bona fide business purpose.

Section 357(c)(1)(A) provides, in the case of an exchange to which section 351 applies, that if the amount of the liabilities assumed exceeds the total of the adjusted basis of the property transferred pursuant to the exchange, the excess is treated as gain from the sale of a capital or noncapital asset, as the case may be.¹⁵²

Considering Zell simply wanted to acquire the real estate partnership interests held by Kanter's grantor trusts, and taking into account Kanter's desire to avoid recognizing gain on the sale to Zell to the extent his grantor trusts had negative capital accounts in the partnership interests, it is clear the rapid series of transactions described above, particularly the transfer of notes receivable to Cashmere, was carried out for no reason other than to avoid Federal income tax. Moreover, Waco's promissory notes to Kanter's grantor trusts ostensibly provided additional tax benefits in that Kanter reported the gains realized on the sale of Cashmere stock to Waco under the installment method, even though Equity paid Waco in full in 1983. In the absence of any showing that Cashmere served any legitimate business purpose before or after the transactions described above, we sustain respondent's determination that the transfers of the partnership interests with negative capital accounts to Cashmere constitute money received by Kanter (through his grantor trusts) and Kanter is taxed on the gain resulting from the transfers up to the full amount of the assumed liabilities.

Cashmere was, at best, a passive investment vehicle as opposed to an operating business, and in this light the transfer of the notes receivable to Cashmere served no business purpose independent of the tax benefits Kanter hoped to reap. The eight notes receivable in question (1) were either payable by Kanter individually or by entities he controlled, (2) reflected a total principal amount approximately equal to the aggregate negative capital accounts of the partnership interests in question, (3) were all dated May 1, 1983, and payable on August 31, 1983, and (4) were all repaid with funds from a TACI account. There is no discernible paper trail evidencing the source of the TACI funds. In the end, the cash paid to Cashmere/Waco on the notes receivable was returned to Kanter (indirectly) in the form of a portion of the cash payment Equity made to Waco for Cashmere's stock.

Considering all the circumstances, we conclude the notes receivable were used as a device to circumvent section 357(c) and resulted in nothing more than a circular transfer of funds between and among Kanter-controlled entities. There is no evidence in the record that the notes receivable represented valid indebtedness.

In the absence of any discernible bases in the notes receivable, we conclude the notes did not increase the aggregate basis in the property Kanter's grantor trusts transferred to Cashmere. Under section 357(c), Kanter was required to recognize as capital gain the excess of the liabilities Cashmere assumed over basis in the property his grantor trusts transferred to Cashmere.

Section 453(e) prescribes special rules applicable to installment sales by related persons. In particular, section 453(e)(1) provides that if a person sells property to a related party (the first disposition) under the installment method, and the related party purchaser then resells the property (the second disposition) within 2 years after the first disposition and before the original seller has received all payments due with respect to the first disposition, the amount realized by the related party on the second disposition is treated as a payment received at that time by the original seller. Section 453(e)(7) provides that subsection (e) shall not apply to a second disposition if neither the first disposition nor the second disposition had as one of its principal purposes the avoidance of Federal income tax.

Section 453(f)(1)(A) and (B) defines the term "related person" for purposes of section 453(e) as a person whose stock would be attributed under section 318(a) (other than paragraph (4) thereof) to the person first disposing of the property or a person who bears a relationship described in section 267(b) to the person first disposing of the property.

Waco's stock was owned entirely by the Bea Ritch Trusts, and the beneficiaries of the Bea Ritch Trusts were members of Kanter's family. In addition, Kanter's family members were the beneficiaries of Kanter's grantor trusts. Because the Waco stock owned by the Bea Ritch Trusts is considered owned by the beneficiaries of the Bea Ritch Trusts under section 318(a)(2)(B)(i), and those same beneficiaries are also the beneficiaries of Kanter's grantor trusts, ownership of the Waco stock is imputed to the grantor trusts under section 318(a)(3)(B)(i).¹⁵³ It follows that the grantor trusts' sale of Cashmere stock to Waco constituted a sale to a related person for purposes of section 453(f)(1)(A). When Waco subsequently, within 2 years, transferred the Cashmere stock to Equity before paying the grantor trusts for the Cashmere stock, the installment method of reporting was no longer available to the grantor trusts (and Kanter) by virtue of section 453(e)(1). In sum, the entire amount Waco realized upon its sale of Cashmere stock to Equity (the second disposition) is treated as received by the grantor trusts at the time of the second disposition. Thus, we sustain respondent's determination that Kanter was not eligible for installment sale reporting.

Issue XIII. Whether Kanter Is Entitled to Research and Development and Business Expense Deductions Related to Immunological Research Corp. for 1979 (STJ report at 147-163)¹⁵⁴

In an amendment to answer, filed November 6, 1989, respondent asserted the Kanters were liable for an increased deficiency for 1979 attributable to the disallowance of a loss of $311,478 the Kanters claimed from Immunological Research Corp. (IRC), an S corporation in which the Kanters held an interest through grantor trusts (i.e., the Pillpoppers Trusts). Respondent determined that IRC was not entitled to a research and development expense of $980,000 or various other business expenses it reported for 1979.

Kanter was counsel of record for the taxpayers in Estate of Cook and was the trial attorney before this Court. Since Kanter was an investor in IRC, he had offered himself as a witness for the taxpayers at the trial of the Estate of Cook case. The Court did not allow Kanter to testify, however, because he was the trial attorney for the taxpayers. In the instant cases, Kanter was not the trial attorney and was before this Court as a party litigant and, therefore, he was allowed to testify as a witness. For present purposes, the Court recites the pertinent facts from Estate of Cook. Kanter contends the Court's holding in Estate of Cook is in error. A more detailed and comprehensive findings of fact can be found in the reported opinion of Estate of Cook. During 1979, Kanter and three other individuals (including George Cook, whose estate was the taxpayer in Estate of Cook, invested in IRC. None of the stockholders in IRC, including Kanter, had any formal educational background or experience in the field of pharmaceutical compounds, which was the business IRC was set to engage in.

Shortly after IRC was organized, IRC entered into a research/licensing agreement with Newport Pharmaceutical International, Inc. (Newport). Newport was then engaged in the manufacture, marketing, research, and development of pharmaceutical compounds. Newport owned an undivided one-half interest in a compound identified as the NPT-15000 series that it had acquired in 1978 from the Sloan-Kettering Memorial Institute for Cancer Research (Sloan- Kettering), the discoverer of the compound. At that time, this particular compound was still in the experimental stage of development.

In the 1978 transaction, Newport also acquired one-half of the "Patent Rights [of the compound], and the inventions and improvements covered thereby, throughout the world." The term "Patent Rights" was comprehensively defined elsewhere in the 1978 sales agreement. In this 1978 sales agreement, Newport was given the exclusive right to exploit the patent rights to the subject compound on a world-wide basis, as to which Newport agreed to use its best efforts to exploit the patent rights for the mutual benefit of itself and Sloan-Kettering. The agreement further allowed Newport to license third parties in connection with the exploitation of the subject compound; however, such licensing agreements, among other things, had to be agreed to by Sloan-Kettering.

IRC ostensibly was organized to engage in a licensing agreement with Newport for exploitation of the NPT-15000 series compound in which Newport held a one-half interest. IRC and Newport entered into such an agreement in 1979 for the compound identified as NPT-15392, which was within the NPT-15000 series. However, the licensing agreement IRC entered into was only with Newport. Sloan-Kettering was not a party to the agreement, did not sign the agreement, and there is no evidence that Sloan-Kettering ever acquiesced in the agreement. Newport and IRC were cognizant of Sloan-Kettering's patent reservation rights, and, accordingly, the licensing agreement between IRC and Newport was structured or attempted to be structured in such fashion that the exploitation of the subject compound by IRC or its licensees would not violate Sloan-Kettering's rights. With that end in mind, the research agreement between IRC and Newport contained the following provision:

In Estate of Cook, this Court sustained the Commissioner's determination disallowing the portion of the $980,000 expense claimed by George Cook as a deduction under section 174(a). The parties agreed in the Estate of Cook case that IRC was not engaged in a trade or business within the meaning of section 162(a). The Kanters here do not contend otherwise. The Kanters contend, however, as Kanter argued for the taxpayers in the Estate of Cook case, that the expense nevertheless qualified as a deduction under section 174(a) as a research or experimentation expense.

This Court, in the Estate of Cook case, held the expense was not a research or experimentation expense within the meaning of section 174(a) based on the premise that, to qualify under section 174(a), two requirements must be satisfied: (1) The taxpayer must have an objective intent to enter into the trade or business envisioned by the licensing agreement, and (2) the taxpayer must demonstrate the capability to engage in such trade or business. The Court went on to conclude that IRC failed to meet both of these tests. Of significance to the Court was the fact that the taxpayers had not established that IRC had obtained any ownership rights in any technology to be developed by Newport because Sloan-Kettering was not a party to and had not consented to the licensing agreement (as required in the 1978 sale by Sloan-Kettering to Newport), and, moreover, the license agreement between Newport and IRC expressly provided that no ownership rights in the technology to be developed by Newport would inure to IRC to the extent that such technology or rights envisioned by the agreement came within the definition of "Patent Rights" as reserved by Sloan-Kettering in the 1978 sale to Newport. The reservation by Sloan-Kettering in the 1978 sale to Newport provided:

There were other facts the Court discussed to support the conclusion IRC was not engaged in a trade or business and did not have the capability to engage in a trade or business. These other findings are not seriously challenged by Kanter in the instant cases, and the Court does not consider it necessary to discuss those factors here.

Kanter was the only witness for petitioners with respect to this issue. No documentary evidence was presented to corroborate Kanter's testimony. Kanter's testimony was directed toward establishing that there were certain rights or the ownership of technology that IRC could acquire from the licensing agreement with Newport that would not fall within the umbrella of the "Patent Rights" exception existing in favor of Sloan-Kettering.

To be entitled to deductions for research and experimental expenditures, a taxpayer is not required to currently produce or sell any product. Moreover, a taxpayer need not be currently engaged in a trade or business in order to qualify for such deductions. Snow v. Commissioner, 416 U.S. 500, 503-504 (1974). Nevertheless, in Green v. Commissioner, 83 T.C. 667, 686-687 (1984), the Court stated:

As the foregoing cases demonstrate, when an entity contracts out the performance of the research and development in which it intends to engage, all of the surrounding facts and circumstances are relevant to the inquiry whether the entity has any realistic prospect of entering into a trade or business with respect to the technology under development. Consideration is given to (1) the intentions of the parties to the contract for the performance of the research and development, (2) the amount of capitalization retained by the entity during the research and development contract period, (3) the exercise of control by the entity over the person or organization doing the research, (4) the existence of an option to acquire the technology developed by the organization conducting the research and the likelihood of its exercise, (5) the business activities of the entity during the period in question, and (6) the experience of the investors in the entity. Absent a realistic prospect that the entity will enter a trade or business with respect to the technology, the entity will be treated as a passive investor, not eligible for deductions under section 174.

As indicated previously, in Estate of Cook v. Commissioner, T.C. Memo. 1993-581, the Court addressed another IRC shareholder's entitlement to a deduction for IRC's claimed 1979 research and development expense. In Estate of Cook, the Court rejected the taxpayers' contention that a realistic prospect existed of IRC's entering into a trade or business to exploit the results of the research and experimentation it acquired from Newport.

Petitioners contend the issues are purely factual and the present cases can be distinguished from the Estate of Cook case on the grounds that (1) Respondent, not petitioners, bears the burden of proof; and (2) Kanter was permitted to testify in these cases. Petitioners argue that the Court's conclusions here with respect to IRC should not be based upon certain "irrelevant" facts concerning Antiviral Research Corp. (ARC) and Biological Research Corp. (BRC), as petitioners imply happened in Estate of Cook. Petitioners maintain that almost all of the facts concerning ARC and BRC that were discussed in the Estate of Cook opinion are irrelevant here because (1) Kanter was not a shareholder of either ARC or BRC, and (2) all events relating to ARC and BRC occurred after 1979. In particular, petitioners assert that much of the documentation cited and relied upon by respondent in respondent's proposed findings of fact is not actually in evidence in the instant cases, in the light of petitioners' specific exclusion in the parties' written stipulation of those portions of the Estate of Cook record regarding ARC and BRC.

On this record, respondent has established that Kanter is not entitled to deduct research and development expenses for 1979 under section 174(a). The evidence establishes that there was no realistic prospect of IRC's entering into a trade or business to exploit the technology relating to the NPT-15392 compound being developed under the IRC-Newport research/licensing agreement. Simply put, there was little, if anything, IRC could acquire from the deal since virtually anything that Newport developed would almost certainly be a patentable property right that could not be owned by IRC.

As this Court previously noted in Estate of Cook v. Commissioner, T.C. Memo. 1993-581: (1) The broad definition of the term "patent rights", as defined in the March 28, 1978, agreement between Newport and Sloan-Kettering, made it virtually impossible for IRC to acquire ownership of anything that could be commercially exploited in a trade or business; (2) the existence of the IRC Shareholders-Newport put/call agreement made it extremely unlikely IRC would ever be able to use, in a trade or business, the research Newport conducted because (a) if the research were sufficiently successful to require the payment of royalties, then Newport likely would exercise its call option allowing it to buy the IRC stock and, (b) if the research were not sufficiently successful to require the payment of royalties, then IRC's shareholders would be motivated to put their IRC shares to Newport in return for Newport common stock; (3) after its initial capital was expended, IRC had no further capital to conduct or finance further research, and the existence of the put and call agreements gave IRC's shareholders no incentive to contribute additional capital to IRC; and (4) some of IRC's shareholders apparently had always wanted to acquire Newport stock, and structuring such an investment as a research and development activity would allow the investors a deduction for their investment.

Although the record in these cases includes Kanter's testimony, testimony which was not allowed in the Estate of Cook case, the Court finds Kanter's testimony unconvincing. Kanter's testimony was in the nature of advocacy as opposed to a presentation of substantive evidence that would show that the conclusions of the Court in Estate of Cook were in error, or that essential and relevant facts had not been presented to the Court in Estate of Cook. Essentially, Kanter misunderstood this Court's reasoning in Estate of Cook. Kanter argued that the Court in Estate of Cook incorrectly assumed that IRC held no technical legal ownership rights in the know-how produced under the research project. Kanter contended that IRC did hold "other valuable rights" in the research know-how outside of any existing and derivative future "patent rights" in the NPT-15000 series of compounds retained by Newport and Sloan-Kettering.¹⁵⁸ However, Kanter was unable to explain or describe what those rights might be, nor was any other evidence presented that would establish or support his contention. Kanter testified:

Indeed, in his testimony, Kanter could not elaborate or describe what realistic prospects IRC would have of exploiting commercially the technology being developed. In view of the broad scope of the existing and potential patent rights Newport and Sloan-Kettering held, it is difficult to believe that a third party, such as a major pharmaceutical company, would want to license from IRC the know-how on NPT-15392 to further develop that technology.

On the basis of the foregoing, the Court holds the Kanters are not entitled to a deduction under section 174 for 1979 with respect to IRC's claimed research and development expense. See Spellman v. Commissioner, 845 F.2d 148 (7th Cir. 1988), affg. T.C. Memo. 1986-403; Diamond v. Commissioner, 92 T.C. 423 (1989), affd. 930 F.2d 372 (4th Cir. 1991); Estate of Cook v. Commissioner, T.C. Memo. 1993-581.

The Court further holds the Kanters are not entitled to deductions under section 162 for 1979 with respect to IRC's claimed business expense deductions. IRC was not engaged in an active trade or business during 1979, as IRC's activities fail to satisfy even the "in connection" with a trade or business standard of section 174. See Estate of Cook v. Commissioner, supra.

Issue XIV. Whether Kanter Received Unreported Partnership Income During 1978 (STJ report at 145-146)

On June 13, 1994, respondent filed an amendment to answer which identified the $4,953 adjustment as "Partnership Income/Loss (Fuel Boss -- Energy Management Systems)".

No evidence regarding this adjustment was offered by either party during the trial of these cases.

After trial, on May 15, 1995, the parties submitted to the Court a stipulation of settlement addressing a number of the adjustments determined in the notice of deficiency for 1978. Paragraph 5 of the stipulation of settlement concerns item 1f from the notice of deficiency and states: "Notice of deficiency adjustment 1(f), 'Schedule C -- Income/Loss.' The Court need not address this adjustment at this time, inasmuch as the parties have agreed that this issue is part of the 'Energy Management' project which is under the jurisdiction of Judge Halpern." The parties' stipulation of settlement, however, does not address item 1h from the notice of deficiency.

Issue XV. Whether the Kanters Are Entitled to a Loss From GLS Associates for 1981 (STJ report at 163-165)¹⁶⁰

On their 1981 income tax return, the Kanters claimed a $4,283 loss from GLS Associates, a partnership, which respondent disallowed in the notice of deficiency.

Respondent, on the other hand, contends petitioners failed to carry their burden of proof under Rule 142(a).

Petitioners failed to propose any findings of fact on this issue in their posttrial opening brief. Petitioners are misguided in their attempt to bootstrap this issue with that of the HGA Cinema Trust case regarding the SLG Partners computer sale/leaseback transaction. SLG Partners was a separate and distinct entity from GLS Associates, and the SLG Partners computer sale/leaseback transaction was a separate and different transaction from the GLS Associates transaction. It was incumbent on petitioners to introduce pertinent evidence on the GLS Associates transaction, as opposed to merely arguing that the GLS Associates transaction was essentially the same as the SLG Partners transaction. Petitioners failed to produce any evidence on this issue, and their self-serving legal arguments on brief do not constitute evidence. Consequently, the Court sustains respondent's determination on this issue. See Rule 142(a).¹⁶¹

Issue XVI. Whether the Kanters Are Entitled to Losses From Equitec for 1983 and 1984 (STJ report at 165-167)¹⁶²

On their 1983 and 1984 income tax returns, the Kanters claimed losses of $83,333 and $161,727, respectively, from an entity named Equitec. Respondent disallowed the Equitec losses.

Respondent, on the other hand, contends that petitioners failed to carry their burden of proof under Rule 142(a).

Issue XVII. Whether the Kanters Are Entitled to an Investment Interest Expense Deduction for 1981 (STJ report at 167-168)¹⁶³

On their 1981 income tax return, the Kanters deducted $45,095 identified as investment interest expense related to GLS Associates. Respondent disallowed this deduction in the notice of deficiency, which stated in pertinent part:

Respondent contends petitioners failed to carry their burden of proof on this issue under Rule 142(a).

Issue XVIII. Whether the Kanters Are Entitled to an Investment Tax Credit Carryover for 1978 (STJ report at 169-170)¹⁶⁴

On their 1978 income tax return, the Kanters claimed a $120,566 investment tax credit carryover. Respondent disallowed the tax credit in the notice of deficiency.

Respondent contends petitioners failed to carry their burden of proof under Rule 142(a).

Petitioners' entitlement to an investment tax credit carryover for 1978 is not addressed in the stipulation of settlement the parties filed with the Court on May 15, 1995. Petitioners now nevertheless contend that the disposition of the credit carryover issue is tied to the resolution of the underlying investment tax credit issue for 1977 -- a year that was not before the Court in these consolidated cases

The Court rejects petitioners' argument as contrary to the burden placed upon them under Rule 142(a). Petitioners presented no evidence to establish the existence of, nor their entitlement to, the claimed carryover. See Leavell v. Commissioner, T.C. Memo. 1996-117.¹⁶⁵ Moreover, petitioners must bear responsibility for submitting to the Court a stipulation of settlement that does not make any reference to this issue. Since there are several factual matters that must be established to prove the amount of the carryover that were not established at trial, the Rule 155 computational process is not a forum within which this matter can be considered. See Price v. Commissioner, T.C. Memo. 1995-290. The Court, therefore, rejects petitioners' argument that this issue is computational under Rule 155. Respondent is sustained on this issue.

Issue XIX. Whether the Kanters Are Entitled to an Interest Deduction for 1986 (STJ report at 171-173)¹⁶⁶

On Schedule E of their 1986 income tax return, the Kanters claimed a $50,380 deduction for "interest computers". Respondent disallowed this deduction in the notice of deficiency.

Here again, the record does not include any substantive evidence regarding the merits of the Equitec computer leasing activity. There likewise is no evidence regarding the merits of the indebtedness upon which the interest payments were purportedly made by the Kanters. As noted in petitioners' brief, respondent disallowed the various expenses claimed in connection with Equitec "on a variety of grounds typically used to attack perceived equipment leasing tax shelters." The fact that the leasing activity generated a profit (for 1986) does not impress the Court as proof that petitioners are entitled to an interest expense deduction for 1986. By the same token, the disallowance of expenses claimed with respect to an activity does not mean that the income or gross receipts of the activity can be disregarded. Section 1.183-1(e), Income Tax Regs., provides, in pertinent part, that "gross income derived from an activity not engaged in for profit includes the total of all gains from the sale, exchange, or other disposition of property, and all other gross receipts derived from such activity." Such gross income shall include, for instance, capital gains and rents received for the use of property that is held in connection with the activity. The gross receipts of an activity, even if the activity is not engaged in for profit, constitute gross income, and there is no provision for the exclusion or the disregarding of such income simply because the expenses related thereto are not deductible.

Petitioners, therefore, failed to sustain their burden of proving their entitlement to an interest deduction of $50,380 for 1986, and the Court rejects petitioners' contention the net income of the activity for 1986 should be disregarded. Respondent's determination on this issue is sustained.

Issue XX. Whether the Kanters Are Entitled to a Business Deduction of $104,231 for 1980 (STJ report at 173-177)

Respondent disallowed a deduction of $104,231 that petitioners claimed on Schedule C of their 1980 tax return. The deduction related to a joint venture between two of Kanter's clients, Feigan and Rappaport, to purchase a painting of George Washington. Kanter was instrumental in bringing the two businessmen together at the start of the venture. The transaction subsequently soured, the painting was returned to its original owner, and, although the seller returned the full purchase price, Rappaport, who provided the funds for the purchase, lost money on account of an intervening decline in the value of the British pound against the U.S. dollar. A dispute between Rappaport and Feigan ensued, Kanter convinced Feigan to make Rappaport whole, and Kanter contributed $104,231 to reimburse Rappaport.

Issue XXI. Whether the Kanters Are Entitled to a Deduction for a Charitable Contribution to the Jewish United Fund for 1982 (STJ report at 177-180)

In a letter to Kanter dated December 30, 1982, JUF acknowledged its receipt of the THC promissory note. The December 30, 1982, letter further stated that "This note has been assigned by you to * * * JUF as a charitable contribution, and we are pleased to accept it as such."

On February 28, 1983, THC paid to Kanter the full $15,000 in principal due on the promissory note, plus interest of $370. On that same date, Kanter then paid $15,000 to JUF by issuing to JUF his own $15,000 check. Kanter did not pay over to JUF the $370 in interest he received on the THC promissory note.

On their 1982 income tax return, the Kanters claimed a $15,000 charitable deduction for Kanter's contribution to JUF. On their 1983 income tax return, the Kanters reported the $370 in interest THC paid on the THC note as interest income. Respondent disallowed the $15,000 JUF charitable contribution deduction claimed by the Kanters.

Respondent contends the Kanters are not entitled to a charitable contribution deduction for 1982 because: (1) There was no endorsement of the THC promissory note by Kanter to JUF, and (2) the Kanters failed to establish the note's fair market value as of the date of its purported contribution to JUF in late 1982.

The record shows that Kanter did not make a payment to JUF during 1982. In short, THC forwarded to JUF a $15,000 promissory note payable to Kanter along with a letter which stated: "THC will pay its note to Kanter, who will, in turn, see to providing these funds to JUF." In accordance with this letter, THC paid $15,370 to Kanter in February 1983, and Kanter forwarded $15,000 to JUF at that time.

On these facts, it is evident Kanter did not endorse the promissory note over to JUF during 1982 or otherwise relinquish control of the promissory note to JUF at any time. In the absence of a payment to JUF during 1982 within the meaning of section 170(a), it follows that the Kanters are not entitled to a charitable contribution deduction for 1982. Nevertheless, Kanter did make a $15,000 charitable contribution to JUF during 1983, and, thus, the Kanters are entitled to a deduction for that year, subject to the adjusted gross income limitations of section 170(b).

Issue XXII. Whether Kanter Is Liable for Self-Employment Tax for 1982 (STJ report at 180-181)¹⁶⁷

Issue XXIII. Whether the Kanters Realized Capital Gains and Losses as Reported on Their 1987 Tax Return (STJ report at 182-198)

Respondent determined in the notice of deficiency issued to the Kanters for 1987 that they were not entitled to capital losses arising from various sales of stocks, bonds, promissory notes, and partnership interests to Mallin, MAF, Inc., Windy City, Inc., and others. These adjustments were resolved against petitioners and the decision entered by the Court at docket No. 24002-91 for the taxable year 1987 on September 24, 2001, was not appealed and is otherwise final. See secs. 7481(a)(1), 7483. Consequently, we need not consider this issue.

Issue XXIV. Additions to Tax and Related Matters

The STJ report, at 265-293, recommended holding (1) the Kanters were liable for additions to tax under sections 6653, 6659, and 6661 for the years in question, and (2) the Kanters were liable for increased interest for 1980, 1984, 1986, and 1987.

Inasmuch as respondent asserted these additions to tax against Kanter strictly as alternatives to respondent's assertion of the fraud additions (which we sustained above with regard to income Kanter earned from The Five), we need not consider the alternative additions to tax.

To reflect the foregoing,

Appropriate orders will be issued (1) striking from respondent's amendment to answer filed at docket No. 31301-87 increased deficiencies for 1978, and (2) granting respondent's oral motion to conform the pleadings to the proof at docket No. 26251-90, and decisions will be entered pursuant to Rule 155.

  Date     Payments              Exhibits

 Title               1982                1983             1984

 Title               1982                1983             1984

 Title               1982                1983             1984

 Date                Amount              Exhibit

          Payments

 Date                     Amount              Exhibit

                                Check

 Date                Amount              Exhibit

                                Check

 Bates Stamped                  Check

                        Check

   Date        Amount        Exhibit

  Date         Amount       Exhibit

              Check                              Check

                          Tax