INVESTMENT RESEARCH ASSOCS. v. COMMISSIONER

T.C. Memo. 1999-407

UNITED STATES TAX COURT

INVESTMENT RESEARCH ASSOCIATES, LTD.,
AND SUBSIDIARIES, ET AL.,1 Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 43966-85, 712-86, Filed December 15, 1999.
45273-86, 1350-87,
31301-87, 33557-87,
3456-88, 30830-88,
32103-88, 27444-89,
16421-90, 25875-90,
26251-90, 20211-91,
20219-91, 21555-91,
21616-91, 23178-91,
24002-91, 1984-92,
16164-92, 19314-92,
23743-92, 26918-92,
7557-93, 22884-93,
25976-93, 25981-93.1

1
Cases of the following petitioners are consolidated
herewith: Burton W. and Naomi R. Kanter, docket No. 712-86;
Investment Research Associates, Ltd., and Subsidiaries, docket
No. 45273-86; Burton W. and Naomi R. Kanter, docket No. 1350-87;
Burton W. and Naomi R. Kanter, docket No. 31301-87; Burton W. and
Naomi R. Kanter, docket No. 33557-87; Burton W. and Naomi R.
Kanter, docket No. 3456-88; Investment Research Associates, Ltd.,
and Subsidiaries, docket No. 30830-88; Burton W. and Naomi R.
(continued...)
 - 2 -

Randall G. Dick and Jeffrey I. Margolis, for petitioners in

docket Nos. 43966-85, 712-86, 45273-86, 1350-87, 31301-87, 33557-

87, 3456-88, 30830-88, 32103-88, 27444-89, 25875-90, 26251-90,

23178-91, 24002-91, 19314-92, 26918-92, 25976-93, and 25981-93.

Royal B. Martin and Steven S. Brown, for petitioners in

docket Nos. 16421-90, 20211-91, 20219-91, 21555-91, 21616-91,

1984-92, 16164-92, 23743-92, 7557-93, and 22884-93.

(...continued)
Kanter, docket No. 32103-88; Investment Research Associates,
Ltd., and Subsidiaries, docket No. 27444-89; Claude M. and Mary
B. Ballard, docket No. 16421-90; Investment Research Associates,
Ltd., and Subsidiaries, docket No. 25875-90; Burton W. and Naomi
R. Kanter, docket No. 26251-90; Claude M. and Mary B. Ballard,
docket No. 20211-91; 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, docket No. 20219-91; 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, docket No. 21555-91; Claude M. and Mary B. Ballard,
docket No. 21616-91; Investment Research Associates, Ltd., and
Subsidiaries, docket No. 23178-91; Burton W. and Naomi R. Kanter,
docket No. 24002-91; Claude M. and Mary B. Ballard, docket No.
1984-92; 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, docket No. 16164-92; Investment Research
Associates, Ltd., and Subsidiaries, docket No. 19314-92; Claude
M. and Mary B. Ballard, docket No. 23743-92; Burton W. and Naomi
R. Kanter, docket No. 26918-92; 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, docket No.
7557-93; Claude M. and Mary B. Ballard, docket No. 22884-93;
Investment Research Associates, Ltd., and Subsidiaries, docket
No. 25976-93; and Burton W. and Naomi R. Kanter, docket No.
25981-93.
 - 3 -

Mark E. O'Leary, John J. Comeau, James M. Cascino, Jonathan

P. Decatorsmith, James M. Klein, G. Roger Markley, and Pamela V.

Gibson, for respondent.

CONTENTS

Issue 1. Whether Payments Made By the Five in the
Prudential, Travelers, and Kanter Transactions During
the Years at Issue Are Properly Taxable to Kanter,
Ballard, and Lisle, and, if so, whether they are liable
for the fraud additions to tax and penalty with respect
to such income . . . . . . . . . . . . . . . . . . . . . 25

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 25

I. Background . . . . . . . . . . . . . . . . . . . . . . . 25
A. Petitioners' Residences and Principal Place of
Business . . . . . . . . . . . . . . . . . . . . . 25
B. Kanter . . . . . . . . . . . . . . . . . . . . . . 26
C. Ballard . . . . . . . . . . . . . . . . . . . . . . 28
D. Lisle . . . . . . . . . . . . . . . . . . . . . . . 29
II. The Kanter Enterprise . . . . . . . . . . . . . . . . . 30
A. Overview . . . . . . . . . . . . . . . . . . . . . 30
B. Investment Research Associates, Inc., and Its
Subsidiaries . . . . . . . . . . . . . . . . . . . 34
1. IRA Stock . . . . . . . . . . . . . . . . . . 34
2. IRA Stockholders . . . . . . . . . . . . . . . 35
a. Mildred Schott and Delores Keating . . . 36
b. The Bea Ritch Trusts . . . . . . . . . . 37
3. IRA Officers and Directors . . . . . . . . . . 40
4. IRA Subsidiaries . . . . . . . . . . . . . . . 41
C. Holding Co. . . . . . . . . . . . . . . . . . . . . 42
D. Administration Co. and Principal Services: The
Banking Corporations . . . . . . . . . . . . . . . 43
E. The Other Lending Corporations . . . . . . . . . . 46
1. HELO . . . . . . . . . . . . . . . . . . . . . 47
2. Int'l Films . . . . . . . . . . . . . . . . . 48
III. Transactions Involving the Five . . . . . . . . . . . . 48
A. The Weaver Arrangement: Hyatt Corp.'s Embarcadero
Hotel Management Contract . . . . . . . . . . . . . 49
B. The Frey Arrangement: Condominium Conversions. . . 57
C. The Schaffel Arrangement: Real Estate Construction
and Financing . . . . . . . . . . . . . . . . . . . 71
1. Schaffel/Prudential Transactions . . . . . . . 73
2. Schaffel/Travelers Transactions . . . . . . . 75
3. FPC Subventure Associates Partnership . . . . 77
 - 4 -

D. The Schnitzer Arrangement: Sale and Repurchase of
Property Management Systems Stock. . . . . . . . . 79
E. The Eulich Arrangement: Essex Hotel Management
Co. . . . . . . . . . . . . . . . . . . . . . . . 88
1. Eulich's Background . . . . . . . . . . . . . 88
2. Prudential's Gateway Hotel . . . . . . . . . . 90
F. Diagram: Summary of Payments From the Five 1977
Through 1989 . . . . . . . . . . . . . . . . . . . 102
G. Changes in IRA and Subsidiaries Corporate
Structure From 1974 Through 1988 . . . . . . . . . 103
H. Changes in Holding Co. & Subsidiaries Corporate
Structure 12/76 Through 8/87 . . . . . . . . . . . 125
I. Holding Co. & Subsidiaries Returns . . . . . . . . 131
J. HELO 1979 Through 1983 . . . . . . . . . . . . . . 140
IV. Flow of Money . . . . . . . . . . . . . . . . . . . . . 141
A. Payments to IRA and Subsidiaries: The Prudential
Transactions . . . . . . . . . . . . . . . . . . . 141
1. Overview . . . . . . . . . . . . . . . . . . . 141
2. Flow of the Funds 1977 Through 1983 . . . . . . 142
a. Flow of Money From KWJ Corp. to IRA:
1978 Through 1983 . . . . . . . . . . . . 143
b. Flow of Money From Zeus: 1979 Through
1983 . . . . . . . . . . . . . . . . . . 146
c. Payments From Schnitzer-PMS, Essex, and
Schaffel 1979 Through 1983 . . . . . . . 150
d. Funds Accumulated in IRA at Close of
1983 . . . . . . . . . . . . . . . . . . 150
3. 1984 Distributions to Carlco, TMT, and BWK,
Inc. . . . . . . . . . . . . . . . . . . . . . 152
a. 1984 Distributions of Cash From IRA to
Carlco, TMT, and BWK, Inc. . . . . . . 152
b. 1984 Distribution of Essex Partnership
Interest to Carlco, TMT, and BWK, Inc. . 153
c. Transfer of Sherwood Partnership
Interest From IRA to Carlco, TMT, and
BWK, Inc. . . . . . . . . . . . . . . . . 155
d. 1984 Distributions to Carlco, TMT, and
BWK, Inc. as Reflected on the Books of
the Corporations . . . . . . . . . . . . 157
4. Flow of Payments by the Five 1985 Through
1989 . . . . . . . . . . . . . . . . . . . . . 158
a. Zeus 1984 Through 1988 . . . . . . . . . 158
b. Distributions of Schnitzer-PMS and Essex
Payments Made During 1985 Through 1989 . 160
c. Loans From IRA to KWJ Partnership
Through 1989 . . . . . . . . . . . . . . 163
d. Balance Sheets of Carlco, TMT, and BWK,
Inc. 1983 Through 1989 . . . . . . . . . 163
 - 5 -

B. Flow of the Funds Paid By the Five Through IRA and
Its Subsidiaries to Kanter, Ballard, and Lisle . . 166
1. Overview . . . . . . . . . . . . . . . . . . . 166
2. Payments from IRA, KWJ Corp., and KWJ Co.
Partnership . . . . . . . . . . . . . . . . . 166
a. 1982: IRA Payments to Ballard and Lisle . 166
b. Consulting Fees Paid to Ballard's and
Lisle's Children . . . . . . . . . . . . 167
c. KWJ Partnership 1989 Payments to Lisle
and Ballard . . . . . . . . . . . . . . . 168
3. Disposition of Funds out of Carlco, TMT, and
BWK to Kanter . . . . . . . . . . . . . . . . 169
a. Creation of Carlco, TMT, and BWK, Inc. . 169
b. Control and Management of Carlco, TMT,
and BWK, Inc. . . . . . . . . . . . . . . 171
c. Ballard: Disposition of Funds out of
TMT . . . . . . . . . . . . . . . . . . 173
d. Lisle: Disposition of Funds out of
Carlco . . . . . . . . . . . . . . . . . 178
e. Kanter: Disposition of Funds out of BWK,
Inc. . . . . . . . . . . . . . . . . . . 180
4. Loans . . . . . . . . . . . . . . . . . . . . 181
a. IRA Loans to Kanter . . . . . . . . . . . 181
b. Loans to Ballard, Lisle, Their Family
Members and Trusts . . . . . . . . . . . 181
5. Writeoff of Loans and Losses . . . . . . . . . 185
C. Payments to Holding Co. and Its Subsidiaries . . . 211
D. Distributions to Kanter . . . . . . . . . . . . . . 212
E. Examination of Petitioners' Returns . . . . . . . . 215

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 226

I. Position of the Parties . . . . . . . . . . . . . . . . 227
II. Omitted Income . . . . . . . . . . . . . . . . . . . . . 229
A. The Transactions . . . . . . . . . . . . . . . . . 230
1. The Hyatt Payments . . . . . . . . . . . . . . 230
2. The Frey Arrangement . . . . . . . . . . . . . 238
3. The Schaffel Arrangement . . . . . . . . . . . 240
4. The Schnitzer Arrangement . . . . . . . . . . 243
5. The Eulich/Essex Arrangement . . . . . . . . . 249
6. Conclusion . . . . . . . . . . . . . . . . . . 255
B. Overview of the Law . . . . . . . . . . . . . . . . 256
1. Sham Corporations . . . . . . . . . . . . . . 258
2. Assignment of Income . . . . . . . . . . . . . 271
3. Section 482 . . . . . . . . . . . . . . . . . 277
4. Conclusion . . . . . . . . . . . . . . . . . . 279
III. Fraud Additions to Tax and Penalties . . . . . . . . . . 286
A. Positions of the Parties . . . . . . . . . . . . . 286
 - 6 -

B. Applicable Statutory Provisions . . . . . . . . . . 287
C. General Legal Principles Relating to Civil Fraud . 289
D. Underpayments of Tax . . . . . . . . . . . . . . . 290
E. Intent to Evade Tax . . . . . . . . . . . . . . . . 300
1. Lisle's Fraud . . . . . . . . . . . . . . . . 303
2. Ballard's Fraud . . . . . . . . . . . . . . . 307
3. Kanter's Fraud . . . . . . . . . . . . . . . . 311
F. Summary and Conclusions as to Fraud . . . . . . . . 318

Issue 2. Whether Certain Commitment Fees Paid to Century
Industries, Ltd., Are Includable in Kanter's Income for
1981, 1982, 1983, 1984, and 1986 . . . . . . . . . . . . 320

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 320

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 326

Issue 3. Whether Kanter Received Unreported Income From Hi-
Chicago Trust for 1981, 1982, and 1983 . . . . . . . . . 331

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 331

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 338

Issue 4. Whether Kanter is Taxable on the Income of the Bea
Ritch Trusts for 1986 and 1987 . . . . . . . . . . . . . 346

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 346

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 359

Issue 5. Whether Kanter Had Unreported Income for 1982,
1983, 1984, 1987, 1988, and 1989 From the CMS Investors
Partnership . . . . . . . . . . . . . . . . . . . . . . 370

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 370

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 370

Issue 6. Whether Kanter had Unreported Income in 1983 From
Equitable Leasing Co., Inc. . . . . . . . . . . . . . . 377

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 377

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 379

Issue 7. Whether Kanter Had Unreported Income in 1982 Based
on the Bank Deposit Analysis Method . . . . . . . . . . 380
 - 7 -

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 380

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 381

Issue 8. Whether Kanter Received Barter Income From
Principal Services in 1988 and 1989 . . . . . . . . . . 385

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 385

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 386

Issue 9. Whether the Kanters Are Entitled to Certain
Deductions Claimed on Schedule A and Schedule C for
1986 Through 1989 . . . . . . . . . . . . . . . . . . . 387

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 387

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 390

Issue 10. Whether Kanter, in 1983, Realized Capital Gains
Under Section 357(b) and (c) From the Assumption by
Cashmere Investment Associates, Inc., of Partnership
Interests Having Negative Capital Accounts and Whether,
Under Section 453, the Installment Method was Available
for the Reporting of Such Gains . . . . . . . . . . . . 391

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 391

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 405

Issue 11. Whether Kanter Is Entitled to Research and
Development and Business Expense Deductions From
Immunological Research Corporation for 1979 . . . . . . 414

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 414

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 418

Issue 12. Whether Kanter had Unreported Partnership Income
for 1978 . . . . . . . . . . . . . . . . . . . . . . . . 429

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 429

Issue 13. Whether the Kanters Are Entitled to a Loss From
GLS Associates for 1981 . . . . . . . . . . . . . . . . 429

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 429
 - 8 -

Issue 14. Whether the Kanters Are Entitled to a Loss From
Computer Leasing Transactions Involving Equitec for
1983 and 1984 . . . . . . . . . . . . . . . . . . . . . 430

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 430

Issue 15. Whether the Kanters Are Entitled to Investment
Interest Expense Deductions for 1981 . . . . . . . . . . 430

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 430

Issue 16. Whether the Kanters Are Entitled to an Investment
Tax Credit Carryover for 1978 . . . . . . . . . . . . . 431

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 431

Issue 17. Whether the Kanters Are Entitled to an Interest
Deduction for 1986 . . . . . . . . . . . . . . . . . . . 434

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 434

Issue 18. Whether the Kanters Received Unreported Interest
Income from a Bank in 1988 . . . . . . . . . . . . . . . 435

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 435

Issue 19. Whether Kanter Is Entitled to a Business Loss
Deduction in 1980 in Connection With the Sale of a
Painting . . . . . . . . . . . . . . . . . . . . . . . . 435

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 435

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 437

Issue 20. Whether the Kanters Are Entitled To Deduct a
Claimed Charitable Contribution of $15,000 to the
Jewish United Fund in 1982 . . . . . . . . . . . . . . . 441

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 441

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 443

Issue 21. Whether the Kanters Are Entitled to Claimed
Capital Gains and Losses for 1987 . . . . . . . . . . . 446

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 446
 - 9 -

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 453

Issue 22. Whether Respondent Correctly Made Adjustments to
the Rental Income, Depreciation, Interest Expense, and
Investment Tax Credits Claimed by Investment Research
Associates, Ltd. (IRA) in Connection with Equipment
Leasing Transactions for 1979, 1980, and 1982 Through
1989 . . . . . . . . . . . . . . . . . . . . . . . . . . 465

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 465

I. Background and Adjustments Made in Deficiency Notices . 465
A. IRA and Cedilla Investment . . . . . . . . . . . . 465
1. Schott . . . . . . . . . . . . . . . . . . . . 467
2. Mallin . . . . . . . . . . . . . . . . . . . . 467
B. Richard Uhl, Funding Systems Corp., and Funding
Systems Asset Management Corp. . . . . . . . . . . 469
C. FSAM Partnership . . . . . . . . . . . . . . . . . 470
II. Equipment Leasing . . . . . . . . . . . . . . . . . . . 470
A. Equipment Leasing Generally . . . . . . . . . . . . 470
B. General Facts Relative to Lack of Economic
Substance, Profit Motive and Residual Value . . . . 470
C. General Facts Relating to Invalid Indebtedness and
Financing Circularity . . . . . . . . . . . . . . . 472
D. Miscellaneous Additional Facts Generally
Applicable to the Transactions . . . . . . . . . . 476
III. The Specific Leasing Transactions . . . . . . . . . . . 476
A. Cedilla Invest.-1976 Domestic (O.P.M.
Transaction) . . . . . . . . . . . . . . . . . . . 476
B. Cedilla Invest.-1977 Domestic Transaction Master
Lease Transaction) . . . . . . . . . . . . . . . . 478
C. Cedilla Invest.-1979 Foreign Transaction (British
Aerospace Transaction) . . . . . . . . . . . . . . 479
D. IRA-1980 Domestic Transaction ("Mini Computer
Transaction") . . . . . . . . . . . . . . . . . . . 487
E. IRA-1980 Foreign/Domestic Transaction ("Alfred
Teves Transaction") . . . . . . . . . . . . . . . 490
F. Cedilla Invest. "Lexet Transactions" . . . . . . . 492
G. Cedilla Invest. "Ben Energy Transactions" . . . . . 495
H. Cedilla Invest. "Dard Systems Transactions" . . . . 498

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 501

I. Leasing Transactions Generally . . . . . . . . . . . . . 501
II. Specific Leasing Transactions . . . . . . . . . . . . . 516
A. Cedilla Invest.-1976 Domestic (O.P.M.
Transaction) . . . . . . . . . . . . . . . . . . . 516
 - 10 -

B. Cedilla Invest. - 1977 Domestic Transaction
(Master Lease Transaction) . . . . . . . . . . . . 518
C. Cedilla Invest.-1979 Foreign Transaction (British
Aerospace Transaction) . . . . . . . . . . . . . . 519
D. IRA-1980 Domestic Transaction (Mini Computer
Transaction) . . . . . . . . . . . . . . . . . . . 524
E. IRA-1980 Foreign/Domestic Transaction (Alfred
Teves Transaction) . . . . . . . . . . . . . . . . 525
F. Cedilla Invest.-"Lexet Transactions", "Ben Energy
Transactions", and "Dard Systems Transactions" . . 526
G. Equitable Leasing . . . . . . . . . . . . . . . . . 529

Issue 23. Whether IRA is Entitled to a Claimed Loss on Form
4797 of $1,073,835 for 1988 . . . . . . . . . . . . . . 536

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 536

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 540

Issue 24. Whether IRA Is Entitled to a Charitable
Contribution Carryover Deduction for 1983 . . . . . . . 545

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 545

Issue 25. Whether IRA Is Entitled to Certain Claimed
Capital Losses for 1985 . . . . . . . . . . . . . . . . 545

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 545

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 548

Issue 26. Whether IRA Is Entitled to Claimed Bad Debt
Deductions for 1987 . . . . . . . . . . . . . . . . . . 556

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 556

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 558

Issue 27. Whether IRA Is Entitled to Claimed Ordinary
Losses on Sales of Notes Receivable for 1987 . . . . . . 561

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 561

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 564

Issue 28. Whether IRA Is Entitled to Certain Capital Losses
for 1987 . . . . . . . . . . . . . . . . . . . . . . . . 571
 - 11 -

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 571

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 572

Issue 29. Whether IRA Is Entitled To Deduct as Business
Expenses Amounts Paid to J.D. Weaver in 1979, 1981, and
1982 . . . . . . . . . . . . . . . . . . . . . . . . . . 574

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 574

Issue 30. Whether the Assessment and Collection of the
Deficiency and Additions to Tax as to IRA for 1980 Are
Barred by the Statute of Limitations . . . . . . . . . . 576

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 576

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 578

Issue 31. Whether IRA Is Liable for the Fraud Addition to
Tax for 1987 . . . . . . . . . . . . . . . . . . . . . . 580

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 580

Issue 32. Whether Assessment and Collection of Federal
Income Taxes of Kanter, Ballard, and Lisle Are Barred
by the Statute of Limitations for Some Years . . . . . . 581

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 581

Issue 33. The Liabilities of Kanter, Ballard, and Lisle for
Additions to Tax for Negligence . . . . . . . . . . . . 582

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 582

Issue 34. Whether the Kanters Are Liable for the Section
6659 Addition to Tax for 1981 . . . . . . . . . . . . . 586

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 586

Issue 35. Whether Kanter Is Liable for Section 6661
Additions to Tax for 1982 Through 1984, and 1986
Through 1988 . . . . . . . . . . . . . . . . . . . . . . 589

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 589

Issue 36. Whether Kanter Is Liable for Section 6621(c)
Increased Interest for 1978, 1979, 1980 Through 1984,
and 1986, and 1987, and 1988 . . . . . . . . . . . . . . 592
 - 12 -

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 592

Issue 37. Whether IRA Is Liable for the Section 6651(a)(1)
Addition to Tax for 1980 . . . . . . . . . . . . . . . . 596

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 596

Issue 38. Whether IRA Is Liable for the Section 6653(a)
Additions to Tax for 1980, and 1982 Through 1988 . . . . 597

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 597

Issue 39. Whether IRA Is Liable for the Section 6659(a)
Additions to Tax for 1982 and 1983 . . . . . . . . . . . 601

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 601

Issue 40. Whether IRA Is Liable for the Section 6661
Additions to Tax for 1983 Through 1988 . . . . . . . . . 602

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 602

Issue 41. Whether IRA Is Liable for the Section 6662(a)
Accuracy-Related Penalty for 1989 . . . . . . . . . . . 606

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 606

MEMORANDUM FINDINGS OF FACT AND OPINION

DAWSON, Judge: These consolidated cases were assigned to

Special Trial Judge D. Irvin Couvillion pursuant to Rules 180,

181, and 183.2 The Court agrees with and adopts the opinion of

the Special Trial Judge, which is set forth below.

2
Unless otherwise indicated, section references are to the
Internal Revenue Code in effect for the years at issue. All Rule
references are to the Tax Court Rules of Practice and Procedure.
 - 13 -

OPINION OF THE SPECIAL TRIAL JUDGE

COUVILLION, Special Trial Judge: In these consolidated

cases, respondent determined deficiencies in petitioners' Federal

income taxes, additions to tax,3 penalties, and increased

interest, as follows:

Investment Research Associates, Ltd., and Subsidiaries

Docket No. 43966-85:
Addition to Tax
Year Deficiency Sec. 6659(a)
1979 $18,791 $5,637

Docket No. 45273-86:
Additions to Tax
Year Deficiency Sec. 6653 Sec. 6659(a) Sec. 6661
1982 $174,225 $8,711 $49,154 $1,038

3
With respect to the additions to tax under sec. 6653, as to
all of the cases before the Court, for the years 1979 and 1980,
the addition to tax is under sec. 6653(a). For the years 1981
through 1985, the addition to tax is under sec. 6653(a)(1). For
the years 1981 through 1985, respondent also determined the
addition to tax under sec. 6653(a)(2), which is 50 percent of the
interest due on the underpayment of tax attributable to
negligence or intentional disregard of rules or regulations. For
the years 1986 and 1987, the addition to tax is under sec.
6653(a)(1)(A), and the determined 50-percent interest due on the
underpayment is under sec. 6653(a)(1)(B). For 1988, the addition
to tax is under sec. 6653(a)(1), and there is no corresponding
addition to tax for 50 percent of the interest due on the
underpayment. See Technical and Miscellaneous Revenue Act of
1988, Pub. L. 100-647, sec. 1015(b)(2)(A), 102 Stat. 3342, 3568,
applicable to returns the due date for which, without regard to
extensions, is after Dec. 31, 1988.
 - 14 -

Docket No. 30830-88:1
Additions to Tax
Year Deficiency Sec. 6653 Sec. 6659(a) Sec. 6661
1983 $595,838 $29,792 $16,767 $134,987
1984 410,317 20,516 -- 102,579
1
In docket No. 30830-88 the deficiencies in tax determined
in the notice of deficiency are $595,838 and $410,317,
respectively, for 1983 and 1984. Page 2 of respondent's opening
brief states the deficiencies to be $181,546 and $123,095,
respectively, for 1983 and 1984. The Court assumes that the
amounts stated in respondent's opening brief are in error.

Docket No. 27444-89:
Additions to Tax
Year Deficiency Sec. 6653 Sec. 6661
1985 $400,488 $20,024 $100,122

Docket No. 25875-90:
Additions to Tax
Year Deficiency Sec. 6653 Sec. 6661
1986 $2,110,643 $105,532.15 $527,660.75

Docket No. 23178-91:
Additions to Tax
Year Deficiency Sec. 6653 Sec. 6661
1987 $5,739,249 $286,962 $1,434,812

Docket No. 19314-92:
Additions to Tax
Year Deficiency Sec. 6651(a)(1) Sec. 6653
1980 $1,304,063 $195,609.45 $65,203.15

Docket No. 25976-93:
Additions to Tax Penalty
Year Deficiency Sec. 6653 Sec. 6661 Sec. 6662(a)
1988 $768,025 $38,401 $192,006 --
1989 878,898 -- -- $175,780
 - 15 -

Burton W. and Naomi R. Kanter
Additions to Tax Penalty
Docket No. Year Deficiency Sec. 6653 Sec. 6659 Sec. 6661 Sec. 6662
712-86 1981 $340,578.00 $17,029.00 $42,682 -- --
1350-87 1982 2,086,913.00 104,346.00 -- $208,691.00 --
31301-87 1978 476,999.00 -- -- -- --
33557-87 1980 454,396.00 22,720.00 -- -- --
3456-88 1979 183,809.37 9,190.47 -- -- --
32103-88 1984 3,825,078.00 191,254.00 -- 949,211.00 --
26251-90 1983 1,150,652.00 57,532.60 -- 287,663.00 --
1986 897,224.00 44,861.00 -- 223,666.00 --
24002-91 1987 1,434,529.00 71,726.45 -- 358,632.25 --
26918-92 1988 523,234.00 26,162.00 -- 130,809.00 --
25981-93 1989 835,847.00 -- -- -- $167,169

Claude M. and Mary B. Ballard

Docket No. 16421-90:
Additions to Tax
Year Deficiency Sec. 6653 Sec. 6661
1982 $55,338 $2,766.90 $8,774

Docket No. 20211-91:
Additions to Tax
Year Deficiency Sec. 6651(a)(1) Sec. 6653 Sec. 6661
1
1984 $981,072 $51,3311 $88,788.05 $245,268
1
On brief, respondent concedes this addition to tax.

Docket No. 21616-91:
Additions to Tax
Year Deficiency Sec. 6653 Sec. 6661
1987 $208,449 $10,422.45 $52,112.25

Docket No. 1984-92:
Additions to Tax
Year Deficiency Sec. 6653 Sec. 6659
1975 $23,453 $1,173 --
1976 34,024 1,701 --
1977 11,502 -- --
1978 3,923 -- --
1979 21,630 -- --
1980 92,481 -- --
1981 193,743 9,687 $17,138

Docket No. 23743-92:
Addition to Tax
Year Deficiency Sec. 6653
1988 $125,136 $6,257
 - 16 -

Docket No. 22884-93:
Penalty
Year Deficiency Sec. 6662
1989 $179,924 $35,985

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
Additions to Tax Penalty
Docket No. Year Deficiency Sec. 6653 Sec. 6661 Sec. 6662(a)
20219-91 1984 $827,955 $41,397.75 $206,988.75 --
21555-91 1987 195,498 9,774.90 48,874.50 --
16164-92 1988 109,048 5,452.00 27,262.00 --
7557-93 1989 109,049 -- -- $21,810

In the following cases, respondent determined in the notices

of deficiency or asserted in amended answers that the

underpayments in tax were subject to increased interest under

section 6621(c), formerly section 6621(d):4

Investment Research Associates, Ltd., and Subsidiaries:

Docket No. Year
43966-85 1979
45273-86 1982

4
Sec. 6621(d)(1) was added by the Deficit Reduction Act of
1984, Pub. L. 98-369, sec. 144(a), 98 Stat. 682, and provides for
interest of 120 percent of the adjusted interest rate due on any
substantial underpayment of tax attributable to tax-motivated
transactions. The increased interest is effective for interest
accruing after Dec. 31, 1984. Sec. 6621(d) was redesignated as
sec. 6621(c) by sec. 1511(c)(1)(A) of the Tax Reform Act of 1986,
Pub. L. 99-514, 100 Stat. 2085, 2744, and repealed by sec.
7721(b) of the Omnibus Budget Reconciliation Act of 1989 (OBRA
89), Pub. L. 101-239, 103 Stat. 2106, 2399, effective for tax
returns due after Dec. 31, 1989, OBRA 89 sec. 7721(d), 103 Stat.
2400.
 - 17 -

Burton W. and Naomi R. Kanter:

Docket No. Year
1350-87 1982
33557-87 1980
1
3456-88 1979
32103-88 1984
26251-90 1983, 1986
24002-91 1987
1
On brief, respondent concedes that the underpayment
attributable to the disallowed loss from Immunological Research
Corp. is not subject to increased interest under sec. 6621(c),
following Estate of Cook v. Commissioner, T.C. Memo. 1993-581.

Claude M. and Mary B. Ballard:

Docket No. Year
16421-90 1982
20211-91 1984
21616-91 1987
1984-92 1975, 1976, 1977, 1978
1979, 1980, 1981
23743-92 1988

Estate of Robert W. Lisle, Deceased, etc.:

Docket No. Year
20219-91 1984
21555-91 1987
16164-92 1988

In amended answers, respondent alleged increases in the

deficiencies in tax and additions to tax in the following cases:
 - 18 -

Petitioner Docket No. Year(s)

Investment Research Associates, 45273-86 1982
Ltd.,and Subsidiaries 43966-85 1979
Burton W. and Naomi R. Kanter 712-86 1981
1350-87 1982
31301-87 1978
33557-87 1980
3456-88 1979
32103-88 1984
26251-90 1983, 1986
24002-91 1987
26918-92 1988
25981-93 1989

Claude M. and Mary B. Ballard 16421-90 1982
20211-91 1984
21616-91 1987
1984-92 1975, 1976, 1977
1978, 1979, 1980
1981
23743-92 1988
22884-93 1989

Estate of Robert W. Lisle, 20219-91 1984
Deceased, etc. 21555-91 1987
16164-92 1988
7557-93 1989

In the amended answers, respondent alleged that the

underpayments in tax with respect to all or, alternatively, with

respect to substantial portions of the increased deficiencies in

tax were subject to the addition to tax for fraud pursuant to

section 6653(b) or the penalty for fraud pursuant to section

6663(a) in the following cases:5

5
For the years 1976 through 1981, the addition to tax for
fraud is under sec. 6653(b). For the years 1982 through 1985,
the addition to tax for fraud is under sec. 6653(b)(1) and (2).
For 1986 and 1987, the addition to tax for fraud is under sec.
6653(b)(1)(A) and (B). For 1988, the addition for fraud is under
(continued...)
 - 19 -

Petitioner Docket No. Year(s)
Investment Research Associates, Ltd. 23178-91 1987
and Subsidiaries
Burton W. and Naomi R. Kanter 712-86 1981
1350-87 1982
31301-87 1978
33557-87 1980
3456-88 1979
32103-88 1984
26251-90 1983, 1986
24002-91 1987
26918-92 1988
25981-93 1989

Claude M. and Mary B. Ballard 16421-90 1982
20211-91 1984
21616-91 1987
1984-92 1975, 1976, 1977
1978, 1979, 1980
1981
23743-92 1988
22884-93 1989

Estate of Robert W. Lisle, 20219-91 1984
Deceased, etc. 21555-91 1987
16164-92 1988
7557-93 1989

Introduction

In each of the cases in which fraud is alleged, respondent

alleged that, if the Court holds that the underpayments in tax

are not subject to fraud additions, alternatively, the

underpayments in tax are subject to additions to tax under

sections 6653(a)(1) and (2) and 6659(a), and the increased

interest under section 6621(c), or if the underpayment is for

1989, that it is subject to a penalty under section 6662.

(...continued)
sec. 6653(b)(1). For 1989, the penalty for fraud is under sec.
6663(a).
 - 20 -

In all of the amended answers in which respondent asserted

increased deficiencies in tax, as well as increased additions to

tax and penalties, respondent did not calculate or assert the

amounts of the increased tax deficiencies or the amounts of the

additions to tax or penalties. Respondent asserted only 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 answers, and as a result of

numerous concessions and stipulations of settlement that were

made 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 some of the cases.6

These cases are part of a larger group of cases that have

also been identified by respondent as a litigation project. The

sobriquet for this project is "Levenfeld/Kanter". These cases

were selected for trial because, as the Court understands, they

involve common issues that the other cases in this project do not

have.

References to Kanter, Ballard, and Lisle are to Burton W.

Kanter, Claude M. Ballard, and Robert W. Lisle, respectively.

Reference to the Kanters, Ballards, and Lisles are to Burton W.

6
In some of the cases, if petitioners are sustained on the
fraud issue, respondent will be barred by the statute of
limitations from assessment as to those petitioners.
 - 21 -

and Naomi R. Kanter, Claude M. and Mary B. Ballard, and Robert W.

and Donna M. Lisle, respectively.

The issues to be decided are:

(1) Whether payments made by the Five in the Prudential,

Travelers, and Kanter transactions during the years at issue are

properly taxable to Kanter, Ballard, and Lisle, and, if so,

whether they are liable for the fraud additions to tax and

penalty with respect to such income;

(2) whether certain commitment fees paid to Century

Industries, Ltd., are includable in Kanter's income for 1981,

1982, 1983, 1984, and 1986;

(3) whether Kanter received unreported income from Hi-

Chicago Trust for 1981, 1982, and 1983;

(4) whether Kanter is taxable on the income of the Bea

Ritch Trusts for 1986, and 1987;

(5) whether Kanter had unreported income for 1982, 1983,

1984, 1987, 1988, and 1989 from the CMS Investors Partnership;

(6) whether Kanter had unreported income in 1983 from

Equitable Leasing Co., Inc.;

(7) whether Kanter had unreported income in 1982 based on

the bank deposit analysis method;

(8) whether Kanter received barter income from Principal

Services in 1988 and 1989;
 - 22 -

(9) whether the Kanters are entitled to certain deductions

claimed on Schedule A and Schedule C for 1986 through 1989;

(10) whether Kanter, in 1983, realized capital gains under

section 357(b) and (c) from the assumption by Cashmere Investment

Associates, Inc., of partnership interests having negative

capital accounts and whether, under section 453, the installment

method was available for the reporting of such gains;

(11) whether Kanter is entitled to research and development

and business expense deductions from Immunological Research

Corporation for 1979;

(12) whether Kanter had unreported partnership income for

1978;

(13) whether the Kanters are entitled to a loss from GLS

Associates for 1981;

(14) whether the Kanters are entitled to a loss from

computer leasing transactions involving Equitec for 1983 and

1984;

(15) whether the Kanters are entitled to investment

interest expense deductions for 1981;

(16) whether the Kanters are entitled to an investment tax

credit carryover for 1978;

(17) whether the Kanters are entitled to an interest

deduction for 1986;
 - 23 -

(18) whether the Kanters received unreported interest

income from a bank in 1988;

(19) whether Kanter is entitled to a business loss

deduction in 1980 in connection with the sale of a painting;

(20) whether the Kanters are entitled to deduct a claimed

charitable contribution of $15,000 to the Jewish United Fund in

1982;

(21) whether the Kanters are entitled to claimed capital

gains and losses in 1987;

(22) whether respondent correctly made adjustments to the

rental income, depreciation, interest expense, and investment tax

credits claimed by Investment Research Associates, Ltd. (IRA) in

connection with equipment leasing transactions for 1979, 1980,

and 1982 through 1989;

(23) whether IRA is entitled to a claimed loss on Form 4797

of $1,073,835 for 1988;

(24) whether IRA is entitled to a charitable contribution

carryover deduction for 1983;

(25) whether IRA is entitled to certain claimed capital

losses for 1985;

(26) whether IRA is entitled to claimed bad debt deductions

for 1987;

(27) whether IRA is entitled to claimed ordinary losses on

sales of notes receivable for 1987;
 - 24 -

(28) whether IRA is entitled to certain capital losses for

1987;

(29) whether IRA is entitled to deduct as business expenses

amounts paid to J.D. Weaver in 1979, 1981, and 1982;

(30) whether the assessment and collection of the

deficiency and additions to tax as to IRA for 1980 are barred by

the statute of limitations;

(31) whether IRA is liable for the fraud addition to tax

for 1987;

(32) whether assessment and collection of Federal income

taxes of Kanter, Ballard, and Lisle are barred by the statute of

limitations for some years;

(33) the liabilities of Kanter, Ballard, and Lisle for

additions to tax for negligence;

(34) whether the Kanters are liable for the section 6659

addition to tax for 1981;

(35) whether Kanter is liable for section 6661 additions to

tax for 1982 through 1984, and 1986 through 1988;

(36) whether Kanter is liable for section 6621(c) increased

interest for 1978, 1979, 1980 through 1984, and 1986, and 1987,

and 1988;

(37) whether IRA is liable for the section 6651(a)(1)

addition to tax for 1980;
 - 25 -

(38) whether IRA is liable for the section 6653(a)

additions to tax for 1980, and 1982 through 1988;

(39) whether IRA is liable for the section 6659(a)

additions to tax for 1982 and 1983;

(40) whether IRA is liable for the section 6661 additions

to tax for 1983 through 1988; and

(41) whether IRA is liable for the section 6662(a)

accuracy-related penalty for 1989.

For convenience and clarity, the Court's findings of fact

and opinion are set forth under each issue. The findings of fact

with respect to any issue incorporate by this reference the

findings of fact as found in any preceding issue.

Issue 1. Whether Payments Made By the Five in the Prudential,
Travelers, and Kanter Transactions During the Years at Issue Are
Properly Taxable to Kanter, Ballard, and Lisle, and, if so,
whether they are liable for the fraud additions to tax and
penalty with respect to such income

FINDINGS OF FACT

The parties have filed several stipulations of fact. The

facts reflected in these stipulations, with the annexed exhibits,

are so found and are incorporated herein by reference.

I. Background

A. Petitioners' Residences and Principal Place of Business

At the time the petitions were filed, the principal place of

business of Investment Research Associates, Ltd. (IRA), was in

the State of Illinois, the Kanters' legal residence was in the
 - 26 -

State of Illinois, the Ballards' legal residence was in the State

of Florida, and the Lisles' legal residence was in the State of

Texas. Donna Lisle died on April 12, 1993, and Robert W. Lisle

died on September 17, 1993. Their two children, Amy L. Albrecht

and Thomas W. Lisle, are the coexecutors of the Estates of Robert

W. Lisle and Donna M. Lisle. The estates have been substituted

as parties and the two children as representatives of the

estates. Amy Albrecht and Thomas Lisle were legal residents of

the State of Texas at the time they were substituted as

representatives of the estates of their deceased parents.

B. Kanter

Kanter is an attorney who has been engaged continuously in

the practice of law in Chicago, Illinois, since about 1956. He

received a J.D. degree from the University of Chicago in 1952.

From 1952 to 1954, he was a teaching associate at the University

of Indiana Law School. Since 1956, his law practice has been in

Chicago, Illinois. His primary expertise is in Federal income

and estate taxation. From 1964 to 1981, Kanter was a partner in

the law firm of Levenfeld & Kanter, which later became Levenfeld,

Kanter, Baskes & Lippitz. That firm was dissolved in 1981, and

Kanter thereafter practiced with the firm of Kanter & Eisenberg.

As of the time of trial, Kanter was of counsel with the Chicago

firm of Neal, Gerber & Eisenberg.
 - 27 -

At the time of the trial and for the prior 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 features of this

publication is the Shop Talk section which he originated. At the

time of trial, Kanter was a senior editor with the Journal of

Taxation. Kanter is generally recognized as well known in his

field. This recognition has resulted in a successful law

practice, which has led to Kanter's being involved in

consultation, development, and investments in a number of

business fields and enterprises. For instance, Kanter has

performed extensive legal work for the Pritzker family, majority

owners of the Hyatt Corp., a major hotel company. Kanter also

served as a director on the boards of several corporations and

charitable organizations.

Petitioner Naomi R. Kanter, Kanter's wife, was not involved

in any of the activities giving rise to this litigation.

However, she filed joint Federal income tax returns with Kanter

for the years at issue.
 - 28 -

C. Ballard

Ballard was an employee in the real estate department of The

Prudential Insurance Co. of America (Prudential) from 1948 until

his retirement in 1982. During the course of his career at

Prudential, Ballard was assigned to several regional offices of

Prudential, including Houston and Dallas, Texas, and beginning in

1966 in the corporate headquarters of Prudential at Newark, New

Jersey, and then again, for a short time, at the Houston regional

office. In 1973, he was reassigned to Prudential's Newark

corporate headquarters, where he remained until his retirement in

early 1982. At the time he left Prudential, Ballard was a senior

vice president in charge of equities and worked under Donald Knab

(Knab), who was in charge of all of Prudential's real estate

operations.

Ballard's work with Prudential in its real estate equity

operations involved the purchase, development, management, and

sale of property. Ballard supervised the staff of this

department at Prudential's headquarters, as well as the real

estate department staff at Prudential's regional and field

offices throughout the United States. Ballard could influence

the choice of builders and contractors for Prudential projects

and could influence or prevent a project from going forward.

Shortly after leaving Prudential, Ballard became a general

partner with Goldman Sachs, an investment firm in New York City.
 - 29 -

In November of 1988, he retired as a general partner and became a

limited partner with Goldman Sachs.

In his position with Prudential, Ballard met and was in

contact with attorneys, developers, businessmen, and contractors

involved in or affected by Prudential's real estate activities.

D. Lisle

Lisle graduated from the University of Missouri with a B.S.

degree in public administration. He attended law school at the

University of Missouri, graduate schools of management and

business at Columbia University, and the graduate school of

management at Princeton University.

Like Ballard, Lisle was employed by Prudential. Lisle

worked for Prudential in real estate development and in mortgage

financing from September 1950 to April 1982. Lisle headed the

division responsible for lending money and buying and building

real estate for Prudential. He had authority to commit any loan

up to $20 million and to award construction contracts. The

development aspect of his work was conducted through a subsidiary

corporation of Prudential known as PIC Realty Corp. (PIC

Realty).7 Lisle was president of PIC Realty.

7
Prudential conducted its real estate equity and joint
venture operations in the name of PIC Realty in those States that
prohibited insurance corporations from directly engaging in real
estate development.
 - 30 -

To a large extent, Lisle's career paralleled Ballard's.

Like Ballard, Lisle worked in various regional offices of

Prudential and ultimately was promoted to a senior executive

position at Prudential's Newark corporate headquarters. The

offices of Lisle and Ballard were next door to each other, and

Lisle's supervisor at Prudential was also Donald Knab. To some

extent, Ballard and Lisle's duties overlapped. At the time Lisle

left Prudential in 1982, he was a vice president of Prudential.

In April 1982, after leaving Prudential, Lisle began working

for The Travelers Insurance Co. (Travelers), doing virtually the

same kind of work he had done for Prudential. He worked for

Travelers until April 1988.

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.

II. The Kanter Enterprise

A. Overview

Kanter met Ballard and Lisle sometime between 1968 and 1970.

The three had numerous contacts and business dealings in

succeeding years.

Kanter entered into arrangements pursuant to which he would

use his business and professional contacts, including his
 - 31 -

relationships with the Pritzkers, Ballard, and Lisle, to assist

individuals and/or entities in obtaining business opportunities

or in raising capital for business ventures. Kanter established

a complex organization of corporations, partnerships, and trusts

to receive, distribute, and disguise the payments from these

arrangements.

Some of these arrangements involved payments from a group of

individuals referred to by the parties as "the Five". The Five

made payments for Ballard's and Lisle's influence in awarding

contracts with Prudential (the Prudential transactions), for

Lisle's influence in awarding contracts with Travelers (the

Travelers transactions), and for Kanter's influence in

transactions that did not involve Prudential or Travelers (the

Kanter transactions). The payments most often were made to

corporations controlled by Kanter and then distributed through

various means to Kanter, Ballard, and/or Lisle, their family

members, or to entities established for the benefit of their

families.

Most of the payments made in the Prudential transactions

were paid through IRA or one of its subsidiaries. Those made in

the Travelers and Kanter transactions generally were made through

another corporation controlled by Kanter, The Holding Co.

(Holding Co.) or one of its subsidiaries. Funds received by IRA

and its subsidiaries and Holding Co. and its subsidiaries, as
 - 32 -

well as funds of other Kanter entities and associates, were

commingled in accounts administered by another Kanter controlled

entity, The Administration Co. (Administration Co.) (and later

Principal Services Corp.).

Some distributions to Kanter, Ballard, and Lisle were

characterized as commissions, consulting fees, or directors fees.

Others were recorded as receivables or loans, many of which were

traded or transferred between the various entities and eventually

written off as uncollectible with IRA and/or Kanter taking

deductions for the writeoffs. Some of the distributions that

were treated as loans were made through two Kanter entities,

International Films, Inc. (Int'l Films) and Harbor Exchange

Lending Operation (HELO).

Large portions of the payments made in the Prudential

transactions eventually were distributed to three of IRA's

subsidiaries; more specifically, 45 percent to Carlco, Inc.

(Carlco) (controlled by Lisle), 45 percent to TMT, Inc. (TMT),

(controlled by Ballard), and 10 percent to BWK, Inc. (controlled

by Kanter).

An overview of the Kanter enterprise is shown by the

following diagram:
- 33 -
 - 34 -

B. Investment Research Associates, Inc., and Its Subsidiaries

IRA was originally incorporated in the State of Delaware on

August 26, 1974, under the name of Cedilla Co. In 1979, the name

of Cedilla Co. was changed to Investment Research Associates,

Ltd. Reference hereinafter to IRA also refers to its

predecessor, Cedilla Co. during years prior to the name change.

1. IRA Stock

At the time of its incorporation in 1974, IRA was authorized

to issue 1,000 shares of 10-cent par value common stock, 8,000

shares of $1 par value class A preferred stock, and 1,000 shares

of 10-cent class B preferred stock. By 1977 IRA was also

authorized to issue 1,000 shares of $5,000 par value class C

preferred stock.

IRA's annual franchise reports filed with the State of

Delaware from 1975 to 1988 reported that the following shares of

stock were issued and outstanding:
 - 35 -

Year Common Preferred
Class A Class B Class C

1975 [blank] [blank] [blank] [not authorized]
1976 [blank] [blank] [blank] [not authorized]
1977 1,000 1,000 500 [not authorized]
1978 1,000 1,000 none none
1979 none 1,000 1,000 none
1980 1,000 1,000 none none
1981 [blank] [blank] [blank] [blank]
1982 none none none none
1983 1,000 1,000 [blank] [blank]
1984 [blank] [blank] [blank] [blank]
1985 [blank] [blank] [blank] [blank]
1986 1,000 -0- -0- -0-
1987 [blank] [blank] [blank] [blank]
1988 [blank] [blank] [blank] [blank]

IRA's end-of-year balance sheets from 1975 to 1989 indicate

the following stockholder equity attributable to the preferred

and common stock:

Year Preferred Common
1975 $1,050 $100
1976 1,050 100
1977 1,000 100
1978 1,000 100
1979 1,000 100
1980 1,000 100
1981 1,000 100
1982 1,000 100
1983 -0- 100
1984 -0- 100
1985 -0- 100
1986 -0- 100
1987 -0- 100
1988 -0- 100
1989 -0- 100

2. IRA Stockholders

IRA's 1976 return reported that no individual, partnership,

corporation, estate, or trust at the end of the year owned (or

was attributed ownership under section 267(c)) 50 percent or more
 - 36 -

of the corporation's total voting stock. IRA's returns reported

that from 1977 through 1982, Solomon Weisgal, trustee of the Bea

Ritch Trusts, owned 50 percent of IRA's voting stock, and Mildred

Schott owned the remaining 50 percent of IRA's voting stock. The

Bea Ritch Trusts owned 1,000 shares of common stock, and Schott

owned 1,000 shares of class A preferred voting stock. IRA's

returns for 1984 through 1989 indicated that no individual,

partnership, corporation, estate, or trust at the end of the year

owned (or was attributed ownership under section 267(c)) 50

percent or more of the corporation's total voting stock.

a. Mildred Schott and Delores Keating

Mildred Schott (Schott) worked as a legal secretary and had

a real estate broker's license. She was introduced to Kanter by

a mutual acquaintance. Before she obtained her broker's license,

she worked as a real estate sales person for Delores Keating

(Keating).

Prior to October 28, 1975, Keating owned 1,000 shares of

common stock of Cedilla Co. On October 28, 1975, Keating's 1,000

shares of common stock were exchanged for 500 shares of the class

B preferred stock, and 1,000 shares of common stock were issued

to the Bea Ritch Trusts. By 1978, Keating's 500 shares of class

B preferred stock were redeemed by the corporation.
 - 37 -

Schott held 1,000 shares of the class A preferred stock

until 1982. She held the stock to enable IRA to hold a corporate

real estate license.

b. The Bea Ritch Trusts

Twenty-five trusts known collectively as the Bea Ritch

Trusts were established in 1969 and were named after Beatrice K.

Ritch, Kanter's mother. Kanter's mother is the named grantor,

ostensibly contributing $100 to each of the 25 trusts.

Originally, when the 25 Bea Ritch Trusts were established in

1969, the beneficiaries of the trusts were Kanter, his family,

and other relatives of Kanter. By about 1977, Kanter had

formally renounced all of his interest as a beneficiary in the

Bea Ritch Trusts. At some time, many additional trusts were

added as beneficiaries to the trusts. The identities of the

beneficiaries of the additional trusts are not in the record.

The original individual and additional trust beneficiaries

of the Bea Ritch Trusts are as follows:

Original Additional
Trust Name Beneficiaries Beneficiaries
BWK Trust Burton Kanter JSK 1st Trust #5
JSK 2d Trust #5
JSK 3d Trust #5
Naomi Trust Naomi Kanter JSK 3d Trust #19
JSK 1st Trust #20
BN Trust Burton & Naomi JSK 1st Trust #4
JSK 2d Trust #4
JSK 3d Trust #4
Joel Trust Burton & Joel JSK 1st Trust #17
Kanter JSK 2d Trust #17
Janis Trust Burton & Janis JSK 3d Trust #15
Kanter JSK 1st Trust #16
 - 38 -

Original Additional
Trust Name Beneficiaries Beneficiaries
Joshua Trust Burton & Joshua JSK 2d Trust #18
Kanter JSK 3d Trust #18
Joel Children's Burton, Naomi, JSK 3d Trust #17
Trust Joel & Joel's JSK 1st Trust #18
children living
from time to time
Janis Children's Burton, Naomi, JSK 2d Trust #16
Trust Janis & Janis JSK 3d Trust #16
children living
from time to time
Joshua Children's Burton, Naomi, JSK 1st Trust #19
Trust Joshua & Joshua's JSK 2d Trust #19
children living
from time to time
JL-1 Trust Burton, Joel, JSK 3d Trust #11
Harriet Blum & JSK 1st Trust #12
Joel's 1st child
JL-2 Trust Burton, Joel, JSK 2d Trust #12
Debbie Blum & JSK 3d Trust #12
Joel's 2d child
JL-3 Trust Burton, Joel, JSK 1st Trust #13
Jeff Blum & JSK 2d Trust #13
Joel's 3d child
JA-1 Trust Burton, Janis, JSK 1st Trust #9
Henry Krakow & JSK 2d Trust #9
Janis' 1st child JSK 3d Trust #9
JA-2 Trust Burton, Janis, JSK 1st Trust #10
Helen Krakow & JSK 2d Trust #10
Janis' 3d child
JA-3 Trust Burton, Janis, JSK 1st Trust #11
Helen Krakow & JSK 2d Trust #11
Janis' 3d child
JS-1 Trust Burton, Joshua, JSK 3d Trust #13
Gerald L. Kanter & JSK 1st Trust #14
Joshua's 1st child
JS-2 Trust Burton, Joshua, JSK 2d Trust #14
Ruth Kanter & JSK 3d Trust #14
Joshua's 2d child
JS-3 Trust Burton, Joshua, JSK 1st Trust #15
Joshua's 3d child JSK 2d Trust #15
& all of the
children of Gerald L.
Kanter living from
time to time
 - 39 -

Original Additional
Trust Name Beneficiaries Beneficiaries
BK Children's Burton, Naomi and JSK 1st Trust #1
Trust all of the children JSK 2d Trust #1
of the Grantor's JSK 3d Trust #1
son living from
time to time
BK Descendant's Burton, Naomi and JSK 1st Trust #2
Trust all of the JSK 2d Trust #2
descendants of the JSK 3d Trust #2
of the Grantor's son
living from time to
time
BK Grandchildren's Burton, Naomi and JSK 1st Trust #3
Trust Burton's Grand- JSK 2d Trust #3
children living JSK 3d Trust #3
from time to time
Lillian Trust Burton, Naomi and JSK 2d Trust #20
Lillian Walker JSK 3d Trust #20
J-1 Wife's Trust Burton, Joel's Wife JSK 1st Trust #6
and the children of JSK 2d Trust #6
Carl I. Kanter JSK 3d Trust #6
living from time
to time
J-2 Husband's Burton, Janis' JSK 1st Trust #7
Trust husband and the JSK 2d Trust #7
children of JSK 3d Trust #7
Aloysius B. and
Helen M. Osowski
J-3 Wife's Trust Burton, Joshua's JSK 1st Trust #8
wife and Ruth & JSK 2d Trust #8
Philip Loshin JSK 3d Trust #8

Solomon Weisgal (Weisgal), an accountant and a longtime

friend and business associate of Kanter, has been the sole named

trustee of the Bea Ritch Trusts since 1969. As trustee of the

Bea Ritch Trusts, Weisgal had 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 a manner he deemed appropriate. Weisgal did not
 - 40 -

act independently as a trustee. Rather, he acted as Kanter

directed in all matters regarding the trusts.

3. IRA Officers and Directors

Prior to October 27, 1975, Keating was president and

secretary of IRA. On October 27, 1975, Keating resigned and

Schott was elected as president and Sharon Meyers (Meyers) as

secretary by the unanimous consent of the directors (Schott,

Meyers, and Patricia Grogan (Grogan)). From 1977 to 1980, the

president of IRA was Schott, and the vice president was Weisgal.

Lawrence Freeman (Freeman), an attorney in Miami, Florida,

was a friend and business associate of Kanter. At Kanter's

request, Freeman served as IRA's president from 1980 to 1989.

Although Freeman was not paid for serving as IRA's president, he

and his law firm received significant legal business through

referrals from Kanter. In 1989, Kanter became IRA's acting

president.

From 1976 through 1980, Schott, Weisgal, and Grogan served

as IRA's directors. From 1981 through 1989, Freeman served as a

director. For most of those years Freeman was the sole director.

Although Ballard was not listed as a director, IRA paid Ballard

$12,500 as directors fees in 1981. IRA deducted $12,500 as a

director fee expense on its 1981 return.

Meyers served as an officer or director of IRA at various

times. Meyers originally worked as Kanter's secretary at
 - 41 -

Kanter's law firm. By the 1970's, her duties at the law firm

evolved to her being an administrative assistant to Kanter. By

1981, she was no longer an employee of the law firm. During the

years at issue, Meyers also served as an officer or director of

many of Kanter's other corporations.

At all times, IRA's officers and directors made decisions

and performed their duties in accordance with Kanter's

instructions.

4. IRA Subsidiaries

IRA owned, from time to time, controlling interests in

several subsidiary corporations. These subsidiary corporations

included Brickell Enterprises, Inc., Cedilla Co., Cedilla

Investment Co., IRA Florida Apartments, Inc., KWJ Corp., Zeus

Ventures, Carlco, TMT, and BWK, Inc. IRA also, at one point,

owned a majority stock interest in Int'l Films.

Carlco, TMT, and BWK, Inc., were incorporated in the State

of Delaware in 1982 but remained inactive until 1983. In

December of 1983, IRA acquired 1,000 shares (100 percent) of the

common stock of each of Carlco, TMT, and BWK, Inc. In December

1983 and January 1984, Carlco, TMT, and BWK, Inc., each issued

shares of preferred stock. Carlco preferred shares were issued

to the Christie Trust established by Kanter for the benefit of

Lisle's family; TMT preferred shares were issued to the Orient

Trust established by Kanter for the benefit of Ballard's family;
 - 42 -

and BWK, Inc., preferred shares were issued to the BK Children's

Trust, the beneficiaries of which were members of Kanter's

family.

C. Holding Co.

Holding Co. was incorporated on December 8, 1976. Holding

Co. owned several subsidiary corporations, including the Citra

Co., Active Business Corp., HELO, LBG Properties, Inc., The

Nominee Corp., Oil Investments, Ltd., Tanglewood Properties,

Inc., and Zion Ventures, Inc.

Kanter, his family, and trusts established for the benefit

of his family, including the Bea Ritch Trusts and the Everglades

Trusts,8 owned substantially all of the stock in Holding Co.

Kanter, Weisgal, Meyers, and Linda Gallenberger

(Gallenberger) most often served as directors and officers of

Holding Co.

Holding Co.'s end-of-year balance sheets indicate the

following stockholder equity attributable to the preferred and

common stock:

Year Common Preferred Paid-in
Class A Class B Class C Class D Capital
1979 $23 $775 $3 $50,000 -- $407,087
1980 23 775 3 50,000 1,500,000 407,087
1981 23 775 3 50,000 -- 407,087

8
The Everglades Trusts 1-5, shareholders in Holding Co., were
grantor trusts in which Kanter was the deemed owner under secs.
671 through 678.
 - 43 -

Prior to August 1981, another Kanter entity, Computer

Placement Services, had a $1,729,300 loan outstanding to Holding

Co. In August 1981, $1,500,000 of the loan was converted to

Holding Co. class D preferred stock. In 1983, the stockholder

equity of class D preferred stock was decreased by $1,499,999 and

the paid-in capital was increased by the same amount.

D. Administration Co. and Principal Services: The Banking
Corporations

The funds of the various Kanter entities (as well as the

funds of some of Kanter's associates) were commingled in accounts

held by Administration Co. and later the Principal Services

Accounting Corp. (Principal Services), both of which were also

controlled by Kanter.

Administration Co. was incorporated in the State of Delaware

on September 21, 1981, and was authorized to do business in the

State of Illinois. Administration Co.'s offices were located

either at Kanter's law firm offices or in close proximity

thereto.9

The sole shareholder of Administration Co. was the Pyramid

Trust. Weisgal was trustee of the Pyramid Trust, and Meyers was

the sole beneficiary.

9
Administration Co. was organized at the insistence of some
of the members of Kanter's law firm who complained that law firm
employees working under Kanter were performing extensive nonlegal
services for which the law firm was not being compensated.
 - 44 -

Meyers was the sole director of Administration Co. and was

its president from 1981 to 1985. Gallenberger was the vice

president of Administration Co. and worked under the direction of

Meyers. When Meyers left Administration Co. in 1985, Kanter

briefly served as acting president of Administration Co., and,

thereafter, Gallenberger became Administration Co.'s president

from 1985 through 1988.10

Administration Co. had several employees, mostly clerical

assistants, bookkeepers, and accountants. Meyers directed the

staff and employees of Administration Co. until 1985. In 1983,

Administration Co. paid $143,489 in employee compensation and

distributed over $500,000 as nonemployee compensation, including

$400,000 to the Rainbow Trusts (Rainbow Trust Nos. 1-25).

Administration Co. administered funds that it collected from

or on behalf of various Kanter entities and associates, referred

to as clients. Administration Co. clients included individuals

(including Kanter, Ballard, and Lisle), corporations (including

IRA, Holding Co., and their subsidiaries), partnerships, trusts,

various Kanter-related entities, and members of Kanter’s law

firm.

10
Gallenberger was an accountant. Shortly after arriving in
Chicago, Illinois, she passed the certified public accountant's
examination. Gallenberger became an employee of Administration
Co. in 1982.
 - 45 -

Administration Co. opened a bank account in Administration

Co.'s name known as the Special E Account. The Special E Account

functioned generally as a checking account for its various

clients. Administration Co.'s books and records reflected each

client's balance in the account and also reflected deposits or

withdrawals affecting that client's account.

Administration Co. also maintained at its bank a second

account known as the Special Account that served more like a

savings or money market account. The moneys in this account were

used to buy certificates of deposit because a higher rate of

return could be realized by aggregating the funds to purchase

larger denomination certificates of deposit.

Funds from both the Special E Account and the Special

Account were lent to Administration Co. clients. Deposits to and

withdrawals from the Special E Account and the Special Account

were posted to the appropriate client accounts. If a client had

a negative balance in the accounts, that debit amount was

recorded as a receivable owed by the client to Administration Co.

Any positive balance a client had in the accounts was considered

money belonging to the client.

Administration Co. issued annual tax statements and reports

to its clients and the Internal Revenue Service (IRS) for the

interest earned by each client on that client's funds in the

Special E Account and the Special Account.
 - 46 -

Administration Co. maintained books and records for each of

its clients and, in many instances, prepared clients' tax

returns. Administration Co. prepared Kanter's income tax returns

for all or some of the years at issue. Administration Co.

charged a fee for its services.

Administration Co. filed for bankruptcy in February 1988,

and Principal Services was organized. All of Principal Services'

outstanding shares of stock were initially owned by ARO Trust, of

which trust Kanter was the trustee.

Principal Services took over a number of Administration

Co.'s clients, including Kanter, IRA, and Holding Co. Principal

Services performed services for clients similar to those provided

by Administration Co. Principal Services also established two

accounts similar to the Special E Account and the Special

Account. During the years at issue, Principal Services made

loans to Holding Co. and BWK, Inc.

In 1990, Gallenberger purchased from ARO Trust all of

Principal Services's shares for $100. In October of 1993,

Principal Services moved (along with all of its clients files) to

Wisconsin.

E. The Other Lending Corporations

During the years at issue Kanter often used two additional

entities, HELO and Int'l Films to distribute funds including
 - 47 -

distributions to Ballard and Lisle or trusts established for the

benefit of their families.

1. HELO

HELO's predecessor, Harbor Investments, Inc., was

incorporated on July 21, 1978, and the stated business purpose

was investments. The name was changed in fiscal year ending

August 31, 1980, to Harbor Exchange Lending Operation. The

Active Business Corp. (Active) owned 100 percent of the voting

stock of HELO. Holding Co. owned 100 percent of the stock of

Active and filed consolidated returns with HELO and Active.

On August 31, 1984, all of the shares of HELO were

transferred by Active to Kanter as the trustee of the ARO Trusts.

At the time of the transfer, HELO's only significant assets were

loan receivables totaling $2,331,326, and its liabilities

included short-term loans of $2,518,589 and long-term loans of

$10,557. Holding Co. also disposed of 100 percent of the voting

stock of Active Corp. in 1984.

Holding Co.'s consolidated returns reported the following

income, net assets, and stockholder equity with respect to

HELO:11

11
The record does not contain the information for 1982.
 - 48 -
08/78 08/79 08/80 08/81 08/83 08/84

Income -- -- $1,485 $4,597 -- $136
Deductions -- ($115) (31,309) (149,974) -- (30)
Total -- (115) (29,824) (145,377) -- 106
NOL -- (115) (29,939) -- (198,135)
Taxable -- (29,939) (175,316) -- (198,029)

Assets
Cash $500 131 4,294 (879,704) $31 322
Receivables -- -- 2,871,082 4,691,912 2,331,326 1,320,059
Money market -- -- 718 259 -- --
Pooled funds -- -- -- -- -- 4,636
Intangibles 151 120 89 27
Total 500 382 2,876,214 3,812,556 2,331,384 1,325,017
Liabilities
Short term -- -- 322,987 849,680 2,518,589 1,522,700
Shareholder -- -- 1,255,600 10,557 -- --
Long term -- -- 1,327,100 3,127,200 10,557
Total -- -- 2,905,687 3,987,437 2,529,146 1,522,700
Net assets 500 382 (29,473) (174,881) (197,762) (197,683)
500
Capital stock 500 500 500 500 500
Ret. earnings (118) (29,973) (175,381) (198,262) (198,183)

2. Int'l Films

Int'l Films was incorporated in September 1973. Although

the record does not disclose who originally owned the stock of

Int'l Films, on August 31, 1984, IRA owned 71 percent of the

voting stock of Int'l Films. As of August 31, 1983, Int'l Films

had loans receivable of $878,227. As of August 31, 1984, Int'l

Films had loans receivable of $1,050,827.

III. Transactions Involving the Five

Prior to and during the years at issue, Prudential was one

of the largest holders of commercial real estate in the United

States. By the late 1970's, Prudential either held or was

responsible for managing an estimated $20 billion in commercial

real estate properties. Prudential also developed commercial
 - 49 -

real properties and provided financing to other real estate

developers for various real estate projects around the country.

As stated previously, Kanter entered into arrangements

pursuant to which he would use his relationships with the

Pritzkers, Ballard, and Lisle to assist individuals and/or

entities in obtaining business opportunities or in raising

capital for business ventures. Some of these arrangements

involved payments by a group of individuals referred to by the

parties as "the Five". The Five include J.D. Weaver (Weaver),

Bruce Frey (Frey), William Schaffel (Schaffel), Kenneth Schnitzer

(Schnitzer), and John Eulich (Eulich).

A. The Weaver Arrangement: Hyatt Corp.'s Embarcadero Hotel
Management Contract

Hyatt Corp. manages hotels in the United States, Canada, and

the Caribbean. As indicated previously, members of the Pritzker

family control Hyatt Corp. Kanter has represented the Pritzkers

for years as their attorney.

The Houston Hyatt Hotel was co-owned by Prudential and

Tenneco Corp. (Tenneco) and managed by Hyatt Corp. Weaver was an

executive with Tenneco. From 1968 through 1972, Ballard and

Weaver were involved in the development of the Houston Hyatt

Hotel, and Ballard negotiated the hotel's management contract

with Hyatt Corp.

During the early 1970's, Prudential was also a participant

in a joint venture to develop and own the Embarcadero Hotel in
 - 50 -

San Francisco. The joint venture participants sought an

experienced major hotel management company to operate the hotel

under a long-term management contract. Del Webb (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 wanted the Hyatt Corp. to obtain the management contract

for the Embarcadero Hotel; the hotel would become the third or

fourth Hyatt-operated hotel in the United States at which major

conventions could be held.

Lisle was supervising development of the Embarcadero Hotel

for Prudential and was involved in the selection of a management

company to manage the hotel. Although Hyatt Corp. was about to

enter into the long-term management contract to operate the

Houston Hyatt Hotel owned by Prudential and Tenneco Corp., Lisle

was not interested in having the Hyatt Corp. manage the

Embarcadero Hotel.

Pritzker offered to pay Weaver, who had worked with Ballard

in developing the Houston Hyatt Hotel, a portion of the

management fees if Weaver helped Hyatt Corp. obtain the

management contract for the Embarcadero Hotel. Weaver then

persuaded Lisle to consider Hyatt Corp. for the Embarcadero

Hotel's management contract.
 - 51 -

Since Ballard had negotiated 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 San

Francisco Embarcadero Hotel.

Subsequently, representatives of the Embarcadero joint

venture participants met with Webb and Pritzker to obtain bids on

the Embarcadero Hotel's management contract. Ballard and Lisle,

as well as other Prudential employees, represented Prudential at

the meeting. For reasons not fully shown in the record,

representatives of Intercontinental Co. were not present at the

meeting, and Webb refused to submit a bid during the meeting

because he thought he had been promised the contract. 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. At the meeting Hyatt Corp.

submitted the only bid, and the management contract was awarded

to Hyatt Corp.

Shortly after being awarded the contract, Hyatt Corp.

entered into an agreement with KWJ Corp., an S corporation solely

owned by Weaver. Under the written agreement dated February 25,

1971, Hyatt Corp. agreed to pay KWJ Corp. a commission generally

equal to 10 percent of Hyatt Corp.'s fees under the Embarcadero

Hotel management contract. The agreement acknowledged that "KWJ"
 - 52 -

was the principal factor in bringing Hyatt Corp. and the owners

of the Embarcadero Hotel together and aiding in the negotiations.

Over the period from about 1972 through 1994, Prudential

eventually built a total of about 10 large, major-convention-size

hotels that Hyatt Corp. managed for it. During discussions about

Hyatt Corp.'s obtaining the management contract on one of the

first of these other hotels built after the Embarcadero Hotel,

Pritzker discussed Weaver's finder's fee with respect to the

Embarcadero Hotel's management contract with Ballard and Lisle.

Pritzker told Ballard and Lisle that Hyatt Corp.'s payment of

this finder's fee was a one-time occurrence. Pritzker told them

that no similar finder's fees would be paid with respect to

future management contracts that Hyatt Corp. obtained for other

Prudential hotels.

The Embarcadero Hotel opened in May 1973. In early 1975, a

dispute arose between Weaver and Hyatt Corp. with regard to the

commission due for 1974. A Hyatt Corp. official informed Weaver

that the Embarcadero Hotel did not generate a net profit for

1974. Weaver claimed that Hyatt Corp. was entitled to $623,201

under its agreement with Prudential and that he was entitled to

10 percent of those fees. Pritzker responded that Weaver's share

of the fees should bear his share of the home office expenses.

By November of 1975, Weaver and Hyatt Corp. had settled the

dispute.
 - 53 -

During the period when Weaver and Hyatt were disputing the

computation of Weaver's share of the management fees, Kanter and

Weaver agreed that IRA would purchase the stock of KWJ Corp. In

a letter to Kanter dated March 10, 1976, Weaver confirmed "our

understanding regarding my granting to your client a right to

purchase all of the outstanding shares of stock of KWJ Corp." for

$150,000. The letter further provided that in addition to the

purchase price for the KWJ Corp. stock, KWJ Corp. would continue

to engage Weaver as its president and chief operating officer.

In addition, Weaver was to receive 30 percent of all payments

made by Hyatt Corp. under the contract with KWJ Corp. for as long

as the contract was in existence, regardless of whether he

performed any services for KWJ Corp.

At that time, Hyatt Corp. was in the process of becoming

privately owned, and Kanter did not want the transfer of the KWJ

Corp. stock to take place until after Hyatt Corp. became

privately owned. Therefore, the agreement was framed as an offer

to sell the stock for a period of 4 years.

On March 14, 1977, Hyatt Corp. paid KWJ Corp. $54,848 for

fees earned during 1976. Sometime prior to November 1978, Hyatt

Corp.'s management contract with the hotel was modified, and

Hyatt Corp. wanted to revise its agreement with KWJ Corp. By

letter dated November 14, 1978, Hyatt Corp. notified Weaver that,

under the proposed change, KWJ Corp. would have been overpaid by
 - 54 -

$54,848 for 1976 and would be due $12,095 for 1977. By letter

dated November 21, 1978, Weaver informed Kanter of the proposed

changes in the Hyatt arrangement. The letter indicated that

Weaver would call Kanter to discuss the proposed change. In a

letter to Hyatt Corp. dated November 30, 1978, Weaver stated that

the KWJ Corp. contract would not be affected by any modifications

to Hyatt Corp.'s Embarcadero Hotel contract. On December 12,

1978, Hyatt Corp. paid KWJ Corp. $60,739 for 1977.

In February 1979, Hyatt Corp. had become a privately owned

entity. By letter dated September 27, 1979, Kanter informed

Weaver that Kanter wanted to proceed with the purchase of the KWJ

Corp. stock, effective retroactively to November 1, 1978. IRA

purchased 100 percent of KWJ Corp.'s outstanding shares of stock

from Weaver. IRA was to pay $10,000 of the purchase price in

November 1979 and the balance by August 1980.

As a result of IRA's purchase of the KWJ Corp. stock, KWJ

Corp. was included as a subsidiary on IRA's 1979 consolidated

return. The 1979 consolidated return reported KWJ Corp.'s 1979

gross receipts of $171,027 and payment of the 30 percent fee to

Weaver of $51,308. The 1979 consolidated return reflected KWJ

Corp.'s assets, liabilities, and net worth as of January 1, 1979,

as follows:
 - 55 -

Assets
Cash $40,626
Accrued income 108,521
Total assets 149,147

Liabilities
Mortgages, notes,
and bonds payable 19,400
Accrued expenses 14,663
Total liabilities 34,063

Net Worth 115,084

Common Stock 1,000
Retained earning
unappropriated 53,968
Previously taxed income 60,116
Total stockholder equity 115,084

The commissions paid over by Hyatt Corp. attributable to

operations from 1978 through 1982 were as follows:

Operating Year Payment Year Payment
1978 1979 --
1979 1980 $171,027
1980 1981 128,671
1981 1982 246,717
1982 1983 245,843

Except for the $171,027 payment received in 1980 from

operations of the Hyatt hotel during 1979 that it reported on its

1979 return, IRA included the payments as income on the returns

for the years of payment.

Hyatt Corp. was not informed about the sale of the KWJ Corp.

stock to IRA and, therefore, continued to send the payments to

Weaver, who then sent the check to IRA. IRA then paid Weaver his

30 percent and deducted the payments as a commission expense.

A letter dated March 29, 1983, from Weaver to Kanter states:
 - 56 -

Attached is the check from the Hyatt Corporation in the
amount of $245,843.00, which represents K.W.J.'s
commission for the year ending December 31, 1982.

Will you please deposit and issue appropriate checks to
the participants.

This represents approximately the same amount as last
year, per the attached balance sheet.

By August 1983, Weaver advised IRA that he wanted to modify

his arrangement with KWJ Corp. The new arrangement provided that

Weaver could retire from any and all activities with respect to

KWJ at any time after December 31, 1983. Weaver would continue

to receive 30 percent of any amount received by KWJ Corp. from

Hyatt Corp. with respect to the management contract of the

Embarcadero Hotel. Weaver's 30-percent interest would pass to

his estate or such other specific persons as he might designate

in writing.

In December 1983, KWJ Corp. was liquidated, and its assets

were distributed to IRA. On January 2, 1984, IRA's new

subsidiaries BWK, Inc. (managed by Kanter), Carlco (managed by

Lisle), and TMT (managed by Ballard) formed a partnership called

KWJ Co. (KWJ Co. partnership). Carlco and TMT each had a 45-

percent interest in the KWJ Co. partnership, and BWK had a 10-

percent interest in the partnership. Hyatt Corp. was not

informed about the liquidation of KWJ Corp. or the formation of

the KWJ Co. partnership at the time of the liquidation and
 - 57 -

formation. Hyatt Corp. continued to send payments to Weaver

until Kanter notified Hyatt Corp. sometime around 1992.

From 1984 through 1989, Hyatt Corp. paid the following

commissions with respect to the Embarcadero Hotel that were

reported as income of the KWJ Co. partnership:

Operating Year Payment Year Payment
1984 1985 $295,415
1985 1986 330,376
1986 1987 327,784
1987 1988 281,926
1988 1989 75,396
1989 1990 24,340

The KWJ Co. partnership paid Weaver his 30 percent and

deducted the payment as a commission expense.

B. The Frey Arrangement: Condominium Conversions.

Bruce Frey (Frey), was a certified property manager, real

estate broker, and insurance broker. Frey began working at the

real estate firm of Downs, Mohl & Co. in 1965. While at Downs,

Mohl & Co., Frey met Kanter. In the early 1970's, Frey formed

D.M. Interstate, Inc., a real estate management company that was

an S corporation. In 1975, James Wold (Wold), became a

shareholder and employee of D.M. Interstate, Inc. Sometime

later, Frey also formed BJF Development, Inc., a corporation that

engaged in real estate development and management. Frey was the

sole shareholder of BJF Development, Inc. Hereinafter, D.M.

Interstate, Inc. and BJF Development, Inc., are each sometimes

referred to as a Frey corporation.
 - 58 -

In 1978 or 1979, Frey began converting rental property into

condominiums. Frey or a Frey Corporation purchased rental

property, refurbished it, and then sold the individual units as

condominiums. Frey or a Frey corporation earned development fees

for managing and supervising the renovation and conversion work

on the property. A condominium project typically involved the

use of a limited partnership. As a partner in the partnership,

Frey or a Frey corporation would also receive profit

distributions that were based upon sales of condominiums. Frey

or his Corporation also earned management fees for their services

in managing the condominium units following the conversion.

Frey's first condominium conversion project was called Moon

Lake Village and involved an apartment building located in

Hoffman Estates, Illinois. A joint venture limited partnership

was formed to purchase the apartment building and convert it to

condominiums. Frey was the general partner in the partnership

and there were several investors who made contributions to the

partnership. A Frey corporation received development fees,

profit participation, and management fees in the Moon Lake

Village project. Neither Kanter nor Prudential was involved in

the Moon Lake Village project.

After successfully engaging in the Moon Lake Village

conversion in 1978, Frey met and consulted with Kanter to obtain

tax advice in connection with that project. During their meeting
 - 59 -

or shortly thereafter, Frey and Kanter discussed Frey's need to

raise capital for future condominium conversion projects. At

that time, condominium conversions were occurring frequently in

metropolitan areas throughout the country, and Frey was faced

with having to raise 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 usually required Frey and other

investors to have a substantial investment in the project.

Kanter said that he could help raise some of the capital Frey

needed for the condominium conversion projects. In consideration

for such assistance, Kanter required Frey to share the

development and management fees that Frey earned from such

projects. Frey agreed to pay Kanter a share of the development

and management fees if Kanter caused a third party to invest

money in a project. Furthermore, if Kanter invested in a

conversion project, he would also share in the profit

participation of the partnership.

From 1978 to 1987, a number of condominium conversion

projects were undertaken by limited partnerships that Frey and

the Frey corporations formed with other investors. Frey or a

Frey corporation often served as the general partner in such

limited partnerships. In many instances, the limited
 - 60 -

partnerships acquired an apartment complex, renovated and

converted it into condominium units, and sold the condominium

units to individual purchasers.

Beginning with Frey's second condominium conversion project,

entities associated with Kanter received limited partnership

interests in many of Frey's condominium conversion projects. The

Kanter entities that received such partnership interests included

Zeus Ventures, Inc. (Zeus), a subsidiary of IRA, and Zion

Ventures, Inc. (Zion), a subsidiary of Holding Co. Kanter also

brought other investors into some of Frey's condominium

conversion projects for which Kanter entities received a share of

development and management fees. Projects in which Kanter

entities received fees or interests included the Lakewood

Associates project and the 535 Michigan Avenue project.

The first condominium conversion project that Frey undertook

involving Prudential was a 1,000-unit townhouse apartment complex

called Village of Kings Creek at Miami, Florida. About 1979,

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 Connecticut Mutual Life Insurance Co. would be
 - 61 -

joining Frey in purchasing the property. Prudential previously

had 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 thought that Prudential's refusal of such offer

might constitute a breach of fiduciary duty as investment manager

of the pension fund. Ballard advised the executive that

Prudential should accept the offer.

On January 16, 1980, the Village of Kings Creek partnership

was formed for the purpose of purchasing the property from

Prudential and converting it into condominiums. In 1980, the

Village of Kings Creek apartment complex was sold by Prudential

to the partnership. Zeus (a subsidiary of IRA) and Zion (a

subsidiary of Holding Co.) became limited partners in this

limited partnership. Kanter also brought in another investor,

First Illinois Enterprises (an Illinois general partnership),

that invested $1.5 million in the project. The financing for the

Village of Kings Creek project came from the following sources:

The First National Bank of Chicago was the first mortgage lender;

Connecticut Mutual Life Insurance Co. and First Illinois

Enterprises were the two primary equity participants.

Under the partnership agreement, Zeus was required to make

an initial contribution of $100,000 for its 6.14-percent interest
 - 62 -

in the partnership. Zion was required to make an initial

contribution of $108,014 for its 6.66-percent interest in the

partnership. In the event of certain circumstances, the partners

agreed to make additional contributions to the partnership. The

partnership agreement provided that the partnership would

reimburse or credit the capital accounts of the Frey corporation,

Frey, Wold, and Zion for "the advances made by them in

negotiating, entering into and performing the terms and

conditions of Purchase and Sale Contract and Contractual

Commitments".

Following Prudential's sale of the Village of Kings Creek

property, the executive in the Miami regional office who had

dealt with Frey in the sale approached Frey about converting

another Prudential apartment property in Florida into

condominiums. Beginning with this property, Prudential

participated in a number of successful condominium conversion

projects with Frey. Most of these projects that Frey and

Prudential undertook were joint ventures.

Frey did not have to raise much capital to engage in these

joint venture projects with Prudential, because Prudential owned

the apartment property to be converted and participated 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
 - 63 -

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. A limited partnership received 50 percent of

the proceeds above Prudential's initial specified amount of the

proceeds from the sale of units. A Frey corporation was

responsible for renovating and converting the property and

selling the condominium units in exchange for development fees

and management fees from the owners of the condominiums for

managing the property after the conversion. Some of the Frey-

Prudential agreements included the Calais and Chatham agreements,

both dated August 1, 1981, the Valleybrook agreement dated

October 1, 1981, Old Forge agreement entered into prior to

October 12, 1981, and The Greens agreement entered into prior to

December 30, 1981.

Frey's agreement that he would share development and

management fees with Kanter entities was formalized in two

separate written agreements each dated October 12, 1981. One

agreement was between Frey and IRA's subsidiary Zeus, and the

other agreement was between Frey and Holding Co.

The written agreement with Zeus covered development fees

from projects in which Prudential apartment properties were being

converted. The letter agreement, from Frey to Meyers (president
 - 64 -

of Zeus), referred to Zeus' "Participation in Proceeds on

Prudential Conversions" and provided:

As requested, we are writing to confirm our prior
agreement regarding the participation in the amounts
realized or to be realized on the condominium
conversion of properties of or for The Prudential
Insurance Company of America ("Prudential").

The terms of this letter agreement shall apply
with respect to all conversions of Prudential
properties heretofore and hereafter.

As used in this letter agreement, the term
"amounts realized" includes all amounts to be received
by the converter as Developers' Fees and shares of
assigned profits but excluding any management or other
fees (which shall be retained by the Manager). * * *

* * * * * * *

Of the amounts received as a Developers' Fee on
Prudential conversions, BJF (or its counterpart in any
future conversion) shall retain 75% of the amount
received in reimbursement for any costs and expenses
paid or incurred by it. BJF shall retain this 75%
amount without regard to the actual amount of its costs
and expenses and without any need to account for the
same. Of the remaining 25%, BJF SHALL RETAIN 80% and
shall distribute the remaining 20% to you.

Of the amounts received as shares of assigned
profits, BJF shall distribute 20% to you and retain the
balance. BJF shall retain amounts under this letter
agreement for itself and for distribution to its
affiliates in such percentages as they have agreed.

BJF shall make all distributions to you not later
than 30 days after the date of this letter or receipt
from Prudential of the Developers' Fees and assigned
profits (as the case may be).

Pursuant to this letter agreement, the BJF corporation paid

the following amounts to Zeus during the years 1980 through 1985:
 - 65 -

Year Zeus
1980 $127,372
1981 105,764
1982 538,781
1983 110,125
Total 882,042

1984 103,500
1985 128,763
Total 232,263

The second letter agreement was from Frey to Kanter as

president of Holding Co. and specifically excluded developers'

fees from projects involving Prudential properties (covered in

the Zeus agreement) but included other amounts related to

projects involving Prudential. The letter agreement referred to

"Participation in Condominium Conversions" and provided:

As requested, we are writing to confirm our prior
agreement regarding the participation by us and our
affiliates in capital contributions, profits and losses
and Developers' Fees (excluding Developers' Fees in
condominium conversions of properties of or for The
Prudential Insurance Company of America and excluding
legal, management or any other fees, which shall be
retained by the recipients) in condominium conversions
of properties.

The provisions of this letter agreement shall
apply in the case of condominium conversions of those
properties listed below and any other condominium
conversions in which we agree to participate. Each of
us may terminate this agreement at any time on forty-
five (45) days or more prior written notice. The
termination, however, shall be effective only with
respect to new condominium conversions (i.e.
conversions of properties not under discussion between
us or otherwise in process on the last day of the
forty-five (45) day period).

The participation in capital contributions and
profits and losses shall be as follows:
 - 66 -

The Holding Company, a Delaware corporation,
its nominees and/or affiliates - ("THC") 33%

Bruce J. Frey and his nominee and/or
affiliates - ("BJF") 67%

The participation in Developers' Fees shall commence
with respect to fees received after October 1, 1981,
and shall be as follows:

Holding Co. 5%
BJF 95%
100%

As used herein, the terms capital contributions,
profits and losses and Developers' Fees refer to those
items allocated or allocable to us and our affiliates.

The properties presently subject to this letter
agreement are those properties which we are converting
as consultant to the Prudential Insurance Company of
America. As you know, we are, of course, also
participating as partners in various other condominium
conversions (e.g. 535 N. Michigan Ave. Condominium,
Lake Howell Condominium, etc.), but our agreements in
those instances are subject to the terms of various
limited partnership agreements.

Pursuant to this second letter agreement, the Frey

corporation paid to Holding Co. $80,616 as a distribution in 1981

and $16,200 from participation in fees in 1983. Payments made in

1982 are not in the record.

On June 15, 1984, BJF Development, Ltd. (the Frey

partnership), an Illinois limited partnership, was formed. Frey,

Wold, and the Frey corporation were the general partners of the

Frey partnership. The limited partners were TSG Holdings, Inc.,

FWID, Ltd., and Holding Co. Under the partnership agreement

Holding Co. was entitled to distributions of 13.125 percent of
 - 67 -

available cash-flow. Generally, the purpose of the partnership

was to conduct business activities related to development of

condominiums and cooperatives and property management.

TSG Holdings, Inc. contributed $750,00 to the Frey

partnership. Transcontinental Services Group, N.V., a

Netherlands Antilles corporation and TSG Holdings, Inc.'s parent

corporation, lent $1.75 million to the Frey partnership.

In addition to other assets contributed to the Frey

partnership, the remaining partners assigned their right to

receive fees under other management, consulting, and/or

partnership agreements, including the Village of Kings Creek,

Lakewood, Calais, Chatham, Valleybrook, The Greens, and Galaxy

Towers that had previously been subject to the letter agreement

between Holding Co. and the Frey corporation. The partnership

agreement also listed two participation agreements with "Burton

J. Kanter" regarding certain condominium conversions. The

agreement indicated that the two participation agreements had

been canceled with respect to new condominium conversions.

A letter dated June 20, 1984, to Kanter described Holding

Co.'s obligation to contribute to the capital of the partnership

as follows:
 - 68 -

With the recording of the Certificate of Limited
Partnership, The Holding Company should:

a. make its cash capital contribution of
$29,913.80 to the Partnership;

b. pay FWID, Ltd. ("FWID"), $86,789.57 for
contributing cash equivalents to the Partnership
on its behalf;

c. issue a $88,387.46 secured note to FWID for
contributing other assets to the capital of the
Partnership on its behalf; and

d. confirm its agreement to remit to FWID its
share of Partnership distributions resulting from
the Partnership's realization of the fees and
profits shown on Part II of Appendix A.

The parties contributed a total of $170,936 in
cash to the capital of the Partnership. See item 8 of
Part 1 of Appendix A. Of this amount, The Holding
Company is responsible for 17-1/2 percent or, as shown
above, $29,913.80.

The parties contributed a total of $495,940.31 in
cash equivalents to the Partnership. The Holding
Company's share of this amount is, as noted above, 17-
1/2 percent or $86,789.54. The cash equivalents
consist of the items shown as numbers 6, 7, and 9 on
Part I of Appendix A. The items are:

6. October 31, 1983, Agreement with
Lazard Freres & Co. $273,547.00

7. April 14, 1983, Real Estate Sale
Agreement as amended with Norman
Rudenberg and Edna Davidson 211,082.00

9. Furniture, fixtures, and
equipment 11,311.31

Total $495,940.31

As shown in the enclosed chart, The Holding
Company's remaining obligation for capital
contributions to the Partnership was $145,798.66. Of
this amount, The Holding Company satisfied $57,409.20
 - 69 -

by the transfer to the Partnership of a 20 percent
interest in the $287,046 of purchase money mortgages
relating to the condominium units at 535 North Michigan
Avenue. Accordingly, after satisfying its share of the
cash capital contributions, The Holding Company's
remaining obligation to FWID is $88,387.46.

The Holding Company now should satisfy its
obligation for the cash contribution to the Partnership
by transferring $29,913.80 in cash to it. The Holding
Company should satisfy its obligation to FWID for the
transfer of the cash equivalents by paying FWID
$86,789.54. In addition, The Holding Company should
satisfy its responsibility for the balance of
$88,387.46 by signing a note for this amount payable to
FWID and pledging as security either third-party paper
or other acceptable collateral.

The note should provide for cash payments as the
Partnership realizes cash from the capital
contributions to it. I believe that you should discuss
the procedures regarding the issuance of the $88,387.46
secured note with Jim Wold or, in my absence, my
associate, Claire Pensyl.

The remaining item is, as noted above, for The
Holding Company to confirm its agreement to remit its
share of Partnership distribution to FWID. The Holding
Company's agreement is to remit distributions (a) only
after The Holding Company has received Partnership
distributions equal to The Holding Company's original
capital contribution of $262,500 and (b) then only in
an amount equal to 13.125 percent of the amount
realized by the Partnership from all the items shown on
Part II of Appendix A. The 13.125 percent equals The
Holding Company's share of all Partnership
distributions under Section 3.2 of the Agreement of
Limited Partnership.

In January 1985, approximately 6 months after the formation

of the partnership, TSG Holdings purchased additional interests

in the Frey partnership for $1,382,575, of which $241,950 was

payable to Holding Co. The purchase price was paid to Holding
 - 70 -

Co. in two installments. The letter dated January 8, 1985,

accompanying the first installment provided as follows:

Enclosed is FWID, Ltd. check number 113 in the
amount of $66,507.00. This check represents your
allocable share of the above-mentioned transaction
after reducing your loan from Bruce Frey by one-half,
or $44,194.00.

The following is a brief analysis of the
transaction, your allocable share and a calculation of
the manner in which check number 113 was derived:

1. Gross Sales Price $1,382,575

2. Ownership Percentage of
BJF Development, Ltd.
(11.1895 divided by 63.94 percent) 17.5

3. Allocable Share of Gross Sales
Proceeds 241,950

4. Sales Proceeds Received to Date 632,575

5. Allocable Share of Sales Proceeds
Received to Date 110,701

6. Less: One-Half of Outstanding Loan
from Bruce Frey
($88,388.00 divided by 2) 44,194

7. Check Number 113 $66,507

The letter dated January 24, 1985, accompanying the second

installment provides as follows:

Enclosed please find check number C 1148 in the
amount of $131,250.00. This check represents the
second and final installment payment with regard to
your sale of partnership interest in BJF Development,
Ltd. to TSG Holdings.
 - 71 -

The entire second installment payment to the
selling partners was $750,000.00. Your allocable share
of the transaction was 17.5 percent, thus equaling the
$131,250.00.

From 1984 through 1987, the Frey partnership paid a total of

$403,954 to Holding Co. ($113,827 in 1984, $256,557 in 1985, and

$33,570 in 1987). Of the $113,827 paid in 1984, $98,437 was

identified as a distribution and $25,391 as Holding Co.'s share

of fees. Of the $256,557 paid in 1985, $197,757 was Holding

Co.'s share of proceeds from the sale of the additional

partnership interest to TSG Holdings, $55,950 as a distribution,

and $2,850 represented participation in developers' fees.

C. The Schaffel Arrangement: Real Estate Construction and
Financing

Schaffel was a mortgage broker and a real estate developer.

In the summer of 1979, Kanter invited Schaffel to dinner at a New

York City restaurant to discuss a business proposition. He told

Schaffel that Ballard and Lisle would also be joining them for

dinner. Schaffel accepted Kanter's invitation. In addition to

learning more about the potential business opportunity that

Kanter had mentioned, Schaffel was eager to meet and socialize

with Ballard and Lisle, as he knew that they were senior

Prudential real estate executives.

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
 - 72 -

in that project. Kanter offered to introduce Schaffel to the

people who wanted to build the casino hotel provided Schaffel

would agree to pay to one of Kanter's entities 50 percent of

Schaffel's brokerage fee earned in the transaction. Schaffel

agreed to pay the fee to an entity that held a real estate

brokerage license. The casino hotel project, however, never

materialized.

Although the casino hotel project fell through, Schaffel

agreed to share certain finder's fees with Kanter in other

projects. With Kanter's "concurrence", Schaffel negotiated a

finder's fee arrangement with Benedict Torcivia (Torcivia),12 the

sole shareholder of Torcon, Inc. (Torcon). At the time, Torcon

was probably the largest general contracting company in New

Jersey. By letter agreement dated July 23, 1979, Torcivia agreed

to pay Schaffel a fee for any construction projects that Schaffel

helped obtain for Torcon. The agreement reached between Kanter

and Schaffel as applied to Schaffel's arrangement with Torcon was

set forth in a letter agreement with IRA dated August 2, 1979, as

follows:

The purpose of this letter is to confirm that I
will pay you fifty (50%) percent of any fees received
by me with respect to construction jobs obtained for
Torcon, Inc. in which I determine that you or your
associates have been instrumental or helpful. My
arrangement with Torcon, Inc. concluded with your

12
Prior to 1979, Schaffel had rented office space from
Torcivia.
 - 73 -

concurrence that said Company will pay to me one (1%)
percent based on the gross amount of the contract price
of any such construction job. It is our understanding
that you will receive payment ordinarily over a period
of time depending on draws under the construction job.
Accordingly, you will expect to receive payment only as
I am paid.

It is further understood that the foregoing
pertains only to negotiated contract situations and
should any bid situation arise, the amount of your
participation will be negotiable.

Schaffel also entered into a finder's fee arrangement with

William Walters (Walters), a real estate developer in Denver,

Colorado, similar to the one with Torcivia, and agreed to share

those fees with IRA.

1. Schaffel/Prudential Transactions

As a result of his introduction to Lisle and Ballard,

Schaffel began doing millions of dollars' worth of business with

Prudential. These business dealings included construction

contracts that he helped obtain for Torcon and financing for a

number of large commercial real properties being developed by

Walters, as well as transactions involving others.

The first transaction Schaffel negotiated with Prudential

was the sale of the IBM headquarters building in Lexington,

Kentucky. The property was brought to Schaffel's attention by

Transatlantic Consultants (Transatlantic), the company brokering

the sale. Schaffel introduced the Transatlantic representative

to Ballard. After the initial meeting with Ballard,

Transatlantic dealt with Prudential's local office in Kentucky.
 - 74 -

Seven months after the initial meeting with Ballard, Prudential

bought the building. Schaffel received a fee from brokering the

sale of the building and paid half of the fee to IRA.

Some of the projects Schaffel assisted Torcivia in obtaining

with Prudential included the Parsippany Business Campus, the

Parsippany Hilton Hotel (located outside of Newark, New Jersey),

the Gateway (located in Newark, New Jersey), and the Interplex

Complex (located in Princeton, New Jersey).

Walters agreed to pay Schaffel a finder's fee with respect

to two joint ventures that Walters helped negotiate with

Prudential. Schaffel entered into separate written agreements

dated October 19, 1981, with Cherry Creek Place Associates II

(Prudential funding of $15.6 million) and Aurora Plaza &

Conference Center, Ltd. (Prudential funding of $17 million), with

respect to the joint ventures. In each agreement, the

partnership acknowledged that Prudential's participation in the

venture was primarily the result of Schaffel's efforts and that

Schaffel was entitled to be compensated.

From 1979 through 1983, pursuant to his arrangement with

Kanter, Schaffel shared with IRA fees from these business deals

with Prudential. Schaffel paid the following amounts from

Prudential transactions to IRA from 1979 through 1983:
 - 75 -

Year Amount
1979 $100,000
1980 244,920
1981 361,525
1982 447,450
1983 30,981
Total 1,184,876

After Ballard and Lisle left Prudential, Schaffel no longer

negotiated any transactions with Prudential.

2. Schaffel/Travelers Transactions

Lisle left Prudential in late 1981. He was employed by

Travelers from April 1982 until April 1988. After Lisle began

working for Travelers, Schaffel met with Lisle and others from

Travelers. Thereafter, Schaffel began brokering substantial

business dealings with Travelers on behalf of Torcon and Walters.

The first project Walters entered into with Travelers was

Stanford Place II. By check dated November 9, 1983, Schaffel

paid IRA $213,750 of the fee earned from Stanford Place II.

After that payment, Schaffel stopped paying IRA a share of the

fees earned on business deals with Travelers. Sometime during

1984, Kanter contacted Schaffel and asked why IRA was not

receiving 50 percent of Schaffel's fees on Travelers

transactions. Schaffel took the position that the August 2,

1979, agreement did not apply to deals with Travelers after Lisle

had left Prudential. Kanter disagreed and maintained that the

August 2, 1979, agreement continued to apply.
 - 76 -

In a letter dated August 28, 1984, to Schaffel, Kanter

stated:

I am bothered by your failure to respect what I would
have considered the essential intent of the agreement
you entered into vis-a-vis the introduction of you to
Prudential and the arrangement under which you would
share the benefits of that introduction in connection
with real estate transactions from which you were able
to earn commissions, as well as the other construction
contracts won by Ben [Torcivia].

I appreciate that there may be some technical
difficulty with the previous agreements as to whether
they extend in the new circumstances to Travelers.
However, in my view Travelers has replaced Prudential
as a principal source of transactions because of the
very personnel to whom you were first introduced.
Accordingly, I am inclined to believe that the
arrangement should have been continued.

Lisle and Schaffel discussed the dispute between Schaffel

and Kanter. Lisle feared a lawsuit might result, and because

such a lawsuit might cause some embarrassment for Lisle at

Travelers, he urged Schaffel to settle the dispute.

Schaffel agreed to resume paying 50 percent of his fees on

business deals with Travelers. Those fees, however, were paid to

Holding Co. rather than IRA.

For some of the Walters projects brokered by Schaffel,

Travelers entered into joint venture agreements with Walters'

company pursuant to which Walters' company contributed the

property and Travelers provided the financing. Travelers entered

into joint ventures with Walters' company for the permanent

financing of Stanford Place II (Travelers provided $15 million
 - 77 -

plus a $31.5 million loan), Cherry Creek National Bank (Travelers

provided $8.25 million plus a $19.95 million loan), the Stanford

Corporate Center (Travelers provided $43,612,622), and Boettcher

Building (a.k.a the Boston Building) (Travelers' contribution to

this project is not reflected in the record). For other Walters

projects brokered by Schaffel, Travelers provided financing

without becoming a partner in the underlying joint venture.

These projects included Orchard Place VIII (Travelers provided a

$9 million loan), Orchard Place VII (Travelers provided a $8.5

million loan), and Cherry Creek Place III (Travelers provided a

$10.8 million loan).

From 1984 through 1986, Schaffel paid a share of his fees on

Walters-Travelers transactions to Holding Co. in the following

amounts:

Year Amount

1984 $600,000
1985 1,160,000
1986 1,003,500
Total 2,763,500

3. FPC Subventure Associates Partnership

On March 21, 1980, Kanter acquired an 8-percent limited

partnership interest in Four Ponds Center Associates (Four

Ponds), a joint venture involving Schaffel and Torcivia. On his

1980 Federal income tax return, Kanter reported his share of the

partnership's losses.
 - 78 -

The FPC Subventure Associates partnership (FPC Subventure)

was formed as of January 1, 1981. The partners of FPC Subventure

and their respective interests were: Lisle, 90 percent; the

Everglades Trust (Roger Baskes, trustee), 9 percent; and Burton

W. Kanter Revocable Trust (Kanter trustee), 1 percent. On

January 1, 1981, Kanter transferred his 8-percent interest in

Four Ponds to FPC Subventure, effectively transferring 90 percent

of his interest in Four Ponds to Lisle in exchange for a

receivable of $2,880 from Lisle.

A joint venture called One River Associates (One River) was

formed as of November 16, 1981. Schaffel and Torcivia were the

general partners. Kanter held an 8-percent interest in One

River. On January 1, 1982, Kanter transferred his interest in

One River to FPC Subventure in exchange for a $2,000 receivable

from FPC Subventure. Beginning in 1982, the 8-percent interest

in One River held by Kanter was treated as held by FPC

Subventure, and 90 percent of the income, loss, and distributions

were allocated to Lisle.

On April 5, 1982, Four Ponds distributed $400,000 to Kanter.

Kanter treated the distribution as a distribution to FPC

Subventure. FPC Subventure retained $5,000 and distributed

$395,000 to the partners, 90 percent to Lisle and 10 percent to

the Kanter trusts. An additional $33,600 was distributed by Four

Ponds to FPC Subventure through Kanter during 1982. During 1982
 - 79 -

Lisle received total distributions of $384,840 from FPC

Subventure. Kanter and Lisle reported on their tax returns their

respective distributive shares of the FPC Subventures'

partnership's income and losses.

D. The Schnitzer Arrangement: Sale and Repurchase of Property
Management Systems Stock.

During the 1960's and 1970's, Schnitzer was a major real

estate developer in the Houston, Texas, area. Schnitzer met

Ballard and Lisle when they worked in Prudential's regional

office in Houston, probably in the late 1960's.

Schnitzer had been involved in developing and managing high-

rise office buildings through Century Development Co., Inc.

(Century Development), a subsidiary of Century, Inc. (Century),

Schnitzer's family holding company.

The real estate development business, however, typically was

cyclical. In 1974, to diversify its operations and to secure a

steady source of earnings, a subsidiary of Century acquired for

$1.3 million the assets of a small real estate management company

called Fletcher Emerson Co., Inc. (Fletcher Emerson).13 Fletcher

Emerson managed office buildings and other commercial real

estate. A relatively small portion of its business included

13
The $1.3 million purchase price was roughly based on a
multiple of five times net earnings. At the time, the company
had before-tax net income of $250,000.
 - 80 -

cleaning or janitorial services on some Texas commercial

properties it managed.

Shortly after Century's subsidiary acquired the assets of

Fletcher Emerson, the subsidiary's name was changed to Fletcher

Emerson Co. and then to Property Management Systems, Inc. For

convenience Property Management Systems, Inc., is hereinafter

referred to as Schnitzer-PMS. Schnitzer became the chairman and

chief executive officer of Schnitzer-PMS.

Originally, Schnitzer-PMS's property management business was

conducted primarily in Houston and Dallas, Texas. Schnitzer-PMS

usually managed office buildings and other commercial real estate

owned by others under property management contracts on a month-

to-month basis. Schnitzer wanted to expand the size of

Schnitzer-PMS's property management business, as Schnitzer-PMS

typically earned only a relatively modest profit margin on its

individual property management contracts. Schnitzer felt that

the only way to increase Schnitzer-PMS's profits was having a

large volume of such management contracts.

Fletcher Emerson had been managing a relatively small number

of Prudential's commercial real properties when Century acquired

its assets in 1974. Schnitzer wanted to develop business from

Prudential and American Building Maintenance Industries (AMBI).

To that end, Schnitzer offered AMBI the opportunity to acquire 50

percent of the company. AMBI, however, declined the offer.
 - 81 -

In 1974, Schnitzer approached Ballard (who Schnitzer had

known for many years and previously had dealt with in developing

office buildings in Houston, Texas) and offered to have Century

give Prudential a 50-percent stock interest in Schnitzer-PMS.

Although Prudential would not be required to pay for the 50-

percent Schnitzer-PMS stock interest, Schnitzer hoped Prudential

would award Schnitzer-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

and invited Schnitzer 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 Knab (who headed Prudential's

real estate department). Prudential was particularly interested

in standardizing the reports it received on the operation 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 Schnitzer-PMS might be a potential conflict

of interest and might present problems under the pension laws.
 - 82 -

Ballard introduced Schnitzer to Kanter sometime between the

early and mid-1970's. At some time prior to September 1976,

Schnitzer and Kanter began discussing the sale of a stock

interest in Schnitzer-PMS to Kanter. Kanter indicated that,

through his business contacts, including the Pritzker family, he

could obtain additional property management business for

Schnitzer-PMS. Before Schnitzer made the offer to Kanter,

Schnitzer had a conversation with Ballard to confirm that Kanter

could bring in business for Schnitzer-PMS.

The initial proposal contemplated that Schnitzer-PMS would

be recapitalized in order to provide for the issuance of two

classes of stock, common and preferred. The preferred stock

would be $1,000 par value per share, one vote per share, priority

as to dividends, when, if, and as declared out of available

earnings and profits up to a maximum of 8 percent of the par

value in the year of declaration, and priority on liquidation.

The common stock would be no par common stock carrying one vote

per share. Kanter's client (IRA) would purchase 50 percent of

the common stock for $50,000 and closing would be set for October

1, 1976.

Because of difficulties in finalizing the agreement,

however, closing did not take place in 1976. In a letter dated

April 12, 1977, to Melvin Dow, Kanter stated:

As you know, the president of The Cedilla Company is
Mildred D. Schott and The Cedilla Company is actively
 - 83 -

engaged in certain phases of real estate activity. We
are hopeful that the sooner the acquisition of * * *
[Schnitzer-PMS] shares can be closed, the sooner that
serious efforts can begin to create that synergism that
could result in a sharply expanded business for * * *
[Schnitzer-PMS] in its property management through the
extensive contacts Schott maintains, the broad scope of
opportunity that may be available to Solomon A. Weisgal
and the opportunities that may arise in the course of
my practice which involves representation of numerous
very wealthy groups holding large property interests.

By letter agreement dated November 7, 1977, Kanter and

Schnitzer agreed that Schnitzer-PMS would be recapitalized and

reorganized as a Delaware corporation with an authorized

capitalization of 250 voting preferred shares of $1,000 par value

each and 108 voting common shares of $1 par value each. Each

preferred share would be entitled to a cumulative preferred

dividend of $80 per year, plus a special one-time dividend equal

to 1/250 of the indebtedness of Schnitzer-PMS to American General

Investment Corp. existing at the time the special dividend was

declared. The special dividend was to be declared when the

assets of the corporation available for payment of dividends

equaled the remaining amount outstanding on the loan. At the

time of the reorganization, $1.1 million that Century Development

had borrowed to purchase Fletcher Emerson was still owing. The

purpose of the special dividend was to permit Century Development

to recover its initial investment. Kanter's client (IRA) had the

option to purchase 51.3 shares of common stock (47.5 percent of

the common stock) in Schnitzer-PMS for $150,000.
 - 84 -

The reorganization was completed on January 31, 1978, and

51.3 shares of the common stock of Schnitzer-PMS were issued to

IRA on February 14, 1978. All shares of Schnitzer-PMS (including

those issued to IRA) were pledged to secure Century Development's

loan balance.

In conjunction with the sale of the Schnitzer-PMS stock to

IRA, IRA and Century entered into a stock agreement. Article III

of the agreement gave Century an option to purchase the

Schnitzer-PMS stock upon the death of last to die of Kanter,

Weisgal, and Schott. Section 3.03 of the stock agreement

provided that the purchase price for IRA’s shares of Schnitzer-

PMS stock would be an amount equal to the sum of:

(a) Eight (8) times the average annual pretax
operating income of the Corporation for the five (5)
full fiscal years of the Corporation ending on or
immediately preceding the Option Date or such lesser
number of full years of operation of the Corporation as
shall have expired from the date of this Agreement;
plus

(b) The difference (but not less than zero) between
(i) the book value of the assets of the Corporation
used in its business of building management, consulting
and cleaning and (ii) the lesser of Three Hundred
Thousand Dollars ($300,000) or one and one-half (1-1/2)
times the Corporation’s average receipts for one (1)
month, computed for the twelve (12) month period
immediately preceding the Option Date; plus

(C) The fair market value of any other assets of the
Corporation.

The computation of operating income in Subsection (a)
hereof shall be computed solely with reference to the
Corporation’s business of building management,
consulting and cleaning. The computation of the
 - 85 -

purchase price shall be made by the certified public
accountants regularly retained by the Corporation.

By late 1977, Schnitzer-PMS's property management business

had increased substantially. Although Prudential had declined

Schnitzer's offer to give Prudential an interest in Schnitzer-

PMS, Prudential became Schnitzer-PMS's biggest customer.

Pursuant to Schnitzer's discussions with Prudential's management

and corporate headquarters staff in 1974, Schnitzer-PMS

standardized its reports on the Prudential commercial real

properties that Schnitzer-PMS managed. By 1977, Schnitzer-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.

Schnitzer-PMS year-end balance sheets and profit/loss

statements for 1976 through 1978 showed the following:
 - 86 -

Assets 1976 1977 1978
Current $529,225 $527,025 $690,257
Property 97,913 127,645 133,970
Other 8,142 36,542 137,459
Total 635,280 691,212 961,686
Liabilities
Current 287,829 156,947 237,681
Long-term 6,515 21,647 33,935
Stockholder equity
Common 1,000 1,000 108
Preferred n/a n/a 250,000
Contributed capital 200,000 200,000 n/a
Retained earnings 139,936 311,618 439,962
Total 635,280 691,212 961,686
Earnings
Revenues
Property management 1,044,173 1,448,101 --
Cleaning 2,343,512 2,811,034 --
Other 39,411 41,352 --
Total 3,427,096 4,300,487 5,977,383
Costs & expenses
Property management 255,824 266,794 4,064,014
Cleaning 1,986,343 2,483,019
General 864,715 1,095,499 1,078,503
Interest 2,599 4,117 3,037
Total 3,109,481 3,849,429 5,145,555

Pretax earnings 317,615 451,058 831,828
Tax allocation 143,163 155,527 --
Net earnings 174,452 295,531 --

By March 1979, Schnitzer had decided that Schnitzer-PMS

should have received more opportunities for new business from

Kanter and his associates and informed Kanter that he wanted to

repurchase the stock held by IRA. Kanter and Schnitzer decided

that one party would set a price at which that party was willing

to either sell its stock to the other or buy the other's stock.

By letter dated July 17, 1979, Kanter informed Schnitzer that IRA

would sell its stock in Schnitzer-PMS or purchase Century

Development Corp.'s stock in Schnitzer-PMS for $3.1 million.
 - 87 -

Schnitzer agreed to buy back IRA's stock for $3.1 million. On

November 30, 1979, Century repurchased the 47.5-percent owned by

IRA in July 1979, for $3.1 million, payable over a 10-year period

with interest. At the time of the repurchase, approximately

$700,000 remained outstanding on the loan from the original

purchase of the Fletcher Emerson assets.

Schnitzer-PMS balance sheets and profit/loss statements for

6 months ending June 30, 1978 and June 30, 1979 showed the

following:

6/30/78 6/30/79
Assets
Cash $124,632.16 $284,760.00
Life insurance 41,968.71 96,144.81
Accounts receivable 555,308.63 496,200.83
Supplies 3,450.04 14,614.58
Prepaid expenses 13,877.99 45,007.01
Transportation equipment 14,101.56 17,268.74
Other equipment 116,190.70 130,547.74
Total 869,529.79 1,084,543.71

Liabilities
Accounts payable 6,569.23 --
Accrued payroll expense 97,763.69 134,094.52
Other accrued expenses 109,892.85 121,486.51
Total 214,225.77 255,581.03

Stockholder's equity
Capital stock 250,108.00 250,108.00
Retained earnings 384,885.60 1,198,788.79
Funds to CDC (431,036.94) (955,412.90)
1977 net income 451,347.36 n/a
1978 net income n/a 335,478.79
Total owner's equity 655,304.02 828,962.68

Total liabilities & 869,529.79 1,084,543.71
equity
 - 88 -

6/30/78 6/30/79

Profit/Loss (6 months) 2,916,478.65 3,650,217.86
Gross income 1,824,034.25 2,485,250.27
Operating expenses 1,092,444.40 1,164,967.59
Operating income 542,291.04 740,191.69
Overhead expense 550,153.36 424,775.90
Income before acquisition 98,806.00 89,178.98
Acquisition expense 451,347.36 335,596.92
Net income

Around the end of 1979 or early 1980, Schnitzer discussed

the sale of Schnitzer-PMS to Minneapolis Honeywell for a price

between $12 million and $13 million. Honeywell, however, decided

not to purchase Schnitzer-PMS.

In 1989, IRA accepted a reduced final payment for early

payment of the balance due on the sale of the stock.

IRA received the following payments of principal and

interest and reported the following gain on the installment sale

of the Schnitzer-PMS stock:

Year Payment Principal Interest Gain
1979 $150,000 $150,000 -- $142,740
1980 533,425 211,468 $321,957 201,233
1981 534,696 309,308 225,388 294,338
1982 361,692 172,441 189,251 164,094
1983 361,692 186,655 175,037 177,621
1984 361,692 202,042 159,650 192,263
1985 361,692 218,696 142,996 208,111
1986 361,692 236,724 124,968 225,266
1987 361,692 256,217 105,475 243,816
1988 361,692 277,360 84,332 263,936
1989 840,423 822,841 17,582 783,016
Total 4,590,388 3,043,752 1,546,636 2,896,434

E. The Eulich Arrangement: Essex Hotel Management Co.

1. Eulich's Background

For many years, Eulich had been a real estate developer of

office buildings, shopping malls, and warehouses in Houston and
 - 89 -

Dallas, Texas. Eulich had known Ballard and Lisle since at least

1965. Eulich dealt with Ballard and Lisle in connection with

Prudential's financing his real estate development work, when

Ballard and Lisle worked in Prudential's Houston regional

office.14 Eulich was also a close personal friend of A.N.

Pritzker. Eulich met Kanter through Pritzker in the late 1960's

or early 1970's. Kanter and Eulich had many business dealings

with each other. Kanter helped raise capital for some of

Eulich's business ventures.

Eulich's real estate development activities were primarily

conducted through Vantage, Inc., a corporation that he owned. 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. Rodeway Inns and Eulich

obtained financing from Prudential for the acquisition of many of

the additional motels. From 1968 through about 1973, Eulich

dealt with Ballard in securing the financing from Prudential for

Rodeway Inns.

In about 1974, Eulich and Prudential became dissatisfied

with the performance of the hotel management company that was

managing and operating 16 Rodeway Inns motels that had been

financed by Prudential. Eulich decided to establish his own

14
After Lisle began working for Travelers in 1982, he dealt
with Eulich in connection with the managing of Travelers'
properties.
 - 90 -

hotel management company, Motor Hotel Management, Inc. (Eulich-

Management), to operate the motels. Eulich-Management was

incorporated on January 1, 1975.

Eulich asked Robert James (James) who had substantial hotel

management experience, to serve as Eulich-Management's president

and to manage Eulich-Management's day-to-day operations. Eulich-

Management's three shareholders eventually included Eulich (who

was the majority shareholder), James, and another longtime

business associate of Eulich.

By the end of 1975, Eulich-Management had 17 management

contracts that were part of the joint venture in which Prudential

was the lender and Eulich's company Vantage, Inc., was the

developer. By the late 1970's, Eulich-Management had a good

reputation in providing hotel management services. Prudential's

real estate department staff generally was satisfied with Eulich-

Management's management of a number of hotel properties in which

Prudential was involved. By about the early 1980's, Eulich-

Management managed hotel properties nationwide in about 20 to 25

States. At that time, however, Eulich-Management did not manage

large hotels.

2. Prudential's Gateway Hotel

In about 1976, Ballard decided that Prudential's real estate

department needed to hire an individual possessing substantial

expertise in hotels and hotel operations. Allen Ostroff
 - 91 -

(Ostroff) had worked for a number of years for Hilton Hotels as a

hotel manager and executive. Ballard hired Ostroff to serve as

Prudential's in-house consultant on hotels and hotel operations.

When Ostroff began working for Prudential, 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 with Knab, Ballard,

and Lisle.

One of Ostroff's first assignments at Prudential was to

improve the operating condition of the Gateway Hotel located a

few blocks from Prudential's corporate headquarters in Newark,

New Jersey. Prudential had recently acquired the Gateway Hotel

through foreclosure, and the hotel was in shabby condition.

Moreover, Prudential wanted to upgrade the hotel because

Prudential executives and individuals transacting business at

Prudential's headquarters office frequently stayed at the hotel.

Ostroff first obtained a Hilton franchise for the Gateway

Hotel.15 Ostroff next hired a new hotel management company to

15
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.
 - 92 -

take over the Gateway Hotel's management and operation. The new

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 Hotel's on-site manager.

Ostroff was extremely successful in turning around and

substantially improving the Gateway Hotel's operating condition.

Prudential executives 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 in actually running

the Gateway Hotel. Over the years, he had delegated more and

more duties in the hotel's operation to Connolly. Connolly

frequently interacted with Prudential executives, including

Ballard and Lisle. Sometime in 1978 or 1979, Connolly met Kanter

at the Gateway Hotel.

In 1981, Connolly informed Ostroff that he was considering

leaving his position as on-site manager of the Gateway Hotel,

because he felt he was not being adequately compensated for his

services. Ostroff attempted unsuccessfully to have Cox increase

Connolly's pay. Ostroff and his superiors at Prudential,

including Ballard, decided to terminate Prudential's management
 - 93 -

contract with Cox and to award the management contract to

Connolly.

Ostroff told Connolly that Prudential wanted him to manage

the Gateway Hotel. Ostroff informed Connolly that he would have

to establish a management company of his own and that all hotel

employees would have to be employees of Connolly's hotel

management company.16 Establishing such a hotel management

company, however, presented a problem for Connolly. The

management company would be required, among other things, to

employ a financial manager and an accounting staff to prepare and

issue the financial reports required by Prudential on the Gateway

Hotel's operations. The full-time employment of such personnel

to perform these and other required services could well be

uneconomical, since Connolly's company would be managing only one

or two hotels.

Ballard introduced Connolly to Eulich. Eulich also knew

Kanter from certain prior business ventures in which Kanter had

helped raise capital. Kanter and Eulich were aware Connolly

would need assistance for his hotel management company. Eulich

also wanted Eulich-Management's business to include the

management of a number of large hotels. He believed that

16
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.
 - 94 -

Kanter's business contacts, including contacts with the Pritzker

family, could be beneficial to Eulich-Management.

Eulich, Kanter, and Connolly decided to organize several

entities to further their objectives. A hotel management company

called Gateway Hotel Management Corp. (Gateway Corp.) was

incorporated in 1981. Another corporation, Essex Hotel

Management Co. (Essex Corp.), was also formed.

A letter from Eulich to Connolly dated October 16, 1981,

indicated that Eulich provided $10,000 for the initial

capitalization of Gateway Corp. The letter also indicated that

initially Essex Corp. owned 80 shares (80 percent) of the Gateway

Corp. stock, that Connolly owned 20 shares (20 percent), and that

Connolly had an option to purchase Essex Corp.'s 80 shares.17

17
The letter stated:

Per our telephone conversation today, I am enclosing
the following material:

1. Your 20 shares of stock in Gateway
Hotel Management Company
representing 20% of the company.

2. A xerox copy of 80 shares of stock owned
by Essex Hotel Management Company
representing 80% of the company.

3. A copy of the minutes of the first
meeting of the Board of Gateway - the
original is being circulated for
signature and will be sent for signature
soon.

4. A xerox copy of your option on the Essex
(continued...)
 - 95 -

By March 2, 1982, however, Connolly owned 100 shares (100

percent) of the Gateway Corp. stock. A stock option agreement

"made and entered into" September 18, 1981, but "executed as of"

March 2, 1982, recites that Connolly owned 100 shares of $1 par

value common stock of Gateway Corp. Under the stock option

agreement, Connolly granted Essex Corp. a 10-year option to

purchase 80 shares of the common stock of Gateway Corp. for $100

per share.18 In consideration for the option, Essex Corp. agreed

to pay Connolly $1,000 per year for the term of the option.

Eulich, Kanter, and Connolly also formed a partnership

called Essex Hotel Management Co. (the Essex partnership or

Essex), which was organized effective January 1, 1982. The

(...continued)
Hotel Management Company stock - the
original is being circulated for
signature currently.

As we discussed on the phone, we will be sending you a
check for $10,000.00 which represents the
capitalization of Gateway that should be used as the
corporation's initial bank deposit. When the first
profit distribution is made we would appreciate your
sending us a check for $2,000 representing 20% of this
capital.

If you have any questions about this transaction,
please let me know. We are looking forward to working
with you in what is hopefully a mutually pleasant and
profitable venture.
18
On Dec. 21, 1984, Essex Corp. assigned its option to
purchase the 80 shares of Gateway Corp. to the Essex partnership.
 - 96 -

partners of Essex and their partnership interests were as

follows:

Partner Partnership Interest
Eulich-Management 47.500
IRA 26.125
Holding Co. 21.375
Connolly 5.000

Although the Essex partnership agreement required its

partners to contribute any capital needed to operate the

partnership, very little, if any, actual capital contributions

were ever required from them. The Essex partnership had no

office, equipment, or employees.

In late 1981, Gateway Corp. entered into a management

contract with Prudential to operate the Gateway Hotel and entered

into a second management contract effective February 1, 1982, to

operate another Hilton-franchised hotel that Prudential owned at

Midland, Texas (the Midland Hotel).19

The Essex partnership entered into "Representation and

Marketing" agreements with Eulich-Management and Gateway Corp.,

also effective January 1, 1982.20 At the time, Eulich-

19
Although Ostroff and Prudential ultimately awarded the
Midland, Texas, hotel's management contract to Gateway Corp.,
Gateway Corp. and Eulich-Management had each submitted bids on
the Midland hotel's management contract. During this time,
Prudential usually obtained bids from at least three hotel
management companies for a particular hotel's management
contract.
20
The Eulich-Management agreement indicates that, although it
was effective as of Jan. 1, 1982, it was executed as of July 5,
(continued...)
 - 97 -

Management managed the Allentown Hilton and the Madison Hotel.

Although both were owned by third parties, Prudential had helped

finance the construction of the two hotels. Essex's agreement

with Eulich-Management (the Eulich-Management/Essex agreement)

required Eulich-Management to pay to Essex 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.

The agreement with Gateway Corp. (the Gateway Corp./Essex

agreement) required Gateway Corp. to pay to Essex 75 percent of

Gateway Corp.'s management fees from the operations of the

Gateway Hotel and the Midland Hotel.

Employees of Eulich-Management performed record-keeping and

reporting services for Gateway Corp. A number of Eulich-

Management's personnel were instructed to do whatever they could

to help Connolly with Gateway Corp.'s operations. For instance,

Eulich-Management employees helped perform the financial and

accounting services that Gateway Corp. required in connection

with its Gateway and Midland hotel management contracts. In yet

another instance, a Eulich-Management employee helped Connolly

with union negotiations. Also, after Prudential awarded the

Midland, Texas, hotel's management contract to Gateway Corp.,

Eulich-Management's employees helped Connolly find an on-site

(...continued)
1982.
 - 98 -

manager for that hotel. Eulich-Management did not charge Gateway

Corp. for these services. IRA and Holding Co., in contrast to

Eulich-Management, provided no services to Gateway Corp.

The Essex partners agreed that Gateway Corp. and Eulich-

Management generally would pay the same fees to the Essex

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

participation agreement was cancelable by a 30- to 90-day notice.

As a result, if a significant change occurred with respect to the

compensation that Gateway Corp. or Eulich-Management received

under a particular hotel management contract, an offsetting

change then could be effectuated in the other consulting and fee

participation agreements Gateway Corp. and Eulich Management had

with Essex.

In late 1983, Eulich-Management received a hotel management

contract for Prudential's Hilton-franchised Twin Sixties Hotel at

Dallas, Texas. A new Eulich-Management/Essex agreement was made

effective January 1, 1984, whereby Eulich-Management agreed to

pay to Essex 70 percent of the fees from the Madison Hotel, 57

percent of the fees from Allentown Hilton, and 57 percent of the

fees from Twin Sixties.21

21
The consulting and participation agreement for the Twin
Sixties hotel was entered into to replace the income that Essex
(continued...)
 - 99 -

Effective January 1, 1986, a new Gateway Corp./Essex

agreement reduced Essex's share of Gateway Corp.'s fees from the

operations of the Gateway Hotel and the Midland Hotel from 75

percent to 40 percent.

Although Eulich-Management was sold by Eulich to an

unrelated company called Aircoa in 1986, Eulich-Management

continued to participate as a partner in Essex until about 1990.

In early 1990, Gateway Corp. lost the management contracts

on the Gateway and Midland hotels and ceased operating. The

Essex partnership terminated by 1991.

During the years 1982 through 1988, Essex reported the

following amounts as received and/or accrued22 commission fee

payments from Gateway Corp. and Eulich-Management:

Year Gateway Eulich-Mgt.
1982 $234,170 $104,121
1983 222,557 235,718
1984 268,663 242,116
1985 225,487 230,847
1986 68,000 123,089
1987 172,963 388,632
1988 142,761 238,889
Total 1,334,601 1,563,412

(...continued)
would lose following the expected termination of Eulich-
Management's management contract for the Allentown Hilton, as the
Allentown Hilton was then in the process of being sold.
22
Essex reported its income on the cash method until 1987.
For the 1987 taxable year and thereafter Essex reported on the
accrual method.
 - 100 -

For the 1989 taxable year, Essex reported $293,261 in total

income from consulting fees from Eulich-Management and Gateway

Corp.

For the taxable years 1982 through 1989, Essex made

distributions to IRA, Holding Co., Connolly, and Eulich-

Management in the following amounts:

Year IRA Holding Connolly Eulich-Mgt.
1982 $86,212 $70,538 $16,500 $156,750
1983 78,375 64,125 15,000 142,500
1984 133,238 109,013 25,499 242,250
1985 120,175 98,325 23,000 218,500
1986 80,465 65,835 15,400 146,300
1987 120,698 98,752 23,100 219,450
1988 117,562 96,118 22,500 213,750
1989 51,727 42,322 9,900 94,051
Total 788,452 645,028 150,899 1,433,551

The distributions to all partners from 1982 through 1989

totaled $3,017,930.
 - 101 -

The following diagram illustrates the Essex arrangement:
 - 102 -

F. Diagram: Summary of Payments From the Five 1977 Through 1989

The following diagram shows the money paid by the Five to

IRA, Zeus, KWJ Corp. and Holding Co. from 1977 through 1989:

Most of the payments made by the Five were attributable to

Ballard's and Lisle's influence in awarding contracts with

Prudential (the Prudential transactions), some were attributable

to Lisle's influence in awarding contracts with Travelers (the

Travelers transactions), and some were attributable to Kanter's

influence in transactions that did not necessarily involve

Prudential or Travelers (the Kanter transactions).
 - 103 -

G. Changes in IRA and Subsidiaries Corporate Structure From
1974 Through 1988

IRA's predecessor, Cedilla Co., was incorporated in 1974.

Keating acquired 1,000 shares of the common stock, and Schott

acquired 1,000 shares of its preferred class A stock. In 1975,

Weaver agreed to sell KWJ Corp. to Kanter's "client". In 1975,

Keating's common stock was exchanged for 500 shares of class B

preferred stock, and Weisgal as trustee of the Bea Ritch trusts

acquired 1,000 shares of the common stock. The Cedilla Co's.

1975 balance sheet at the end of 1975 reflected the following:

Assets
Cash $564
Loans receivable 21,100
Prepaid expenses 89
Total 21,753
Liabilities 5,000
Net assets 16,753

Capital stock
Preferred 1,050
Common 100
Capital surplus 50
Retained earnings 15,553

The following series of diagrams illustrates the changes in

the IRA organizations during the years at issue to accommodate

the various transactions.
 - 104 -

1976-77

Cedilla Co. acquired Cedilla Investment Co. (engaged in

equipment leasing transactions) in December 1976. During 1976

Kanter negotiated IRA's purchase of KWJ Corp. from Weaver and

began discussing the purchase of Schnitzer-PMS from Schnitzer.

In 1977 Keating's preferred stock was redeemed.

IRA's consolidated returns for 1976 and 1977 reported

consolidated net losses23 of $7,954 in 1976 and $271,394 in 1977,

a net loss for Cedilla Investment Co. of $174,003 in 1976 and

$345,950 in 1977, and reflected the following income and end-of-

year balance sheets with respect to IRA (unconsolidated):

23
During the years at issue the consolidated net losses did
not equal the total of the net losses of the consolidated group
because of special deductions.
 - 105 -

1976 1977
Income
Gross receipts $640,000 $112,982
Dividends -- 9,217
Interest 9,525 9,409
Partnership (260,934) 5,214
Total 388,591 136,822

Deductions
Compensation/officers -- 19,300
Salaries/wages -- 986
Commissions 213,333 12,000
Other 9,209 22,866
Total 222,542 55,152
Net Income 166,049 81,670
Special deductions (7,114)
Taxable Income 166,049 74,556

Assets
Cash 301,401 134,270
Loans receivable 40,000 370,500
Securities
Marketable 15,663 290,213
Non-marketable -- 65,000
Investment in sub. 15,000 15,000
Investment in pship (185,834) (180,620)
Cedilla trust -- 5,000
Other 361 2,213
Total 186,591 701,576
Liabilities
Payables -- 2,000
Short term -- 65,000
Long term -- 370,000
Other 6,900 3,182
Total 6,900 440,182
Net assets 179,691 261,394
Capital stock
Preferred 1,050 1,000
Common 100 100
Capital surplus 50
Retained earnings 178,491 260,344
Cost of treasury stock -- (50)
 - 106 -

1978

In January 1978, IRA purchased the Schnitzer PMS stock. In

1978, Cedilla Co. changed its name to Investment Research

Associates, Ltd. (IRA). In April 1978, IRA acquired 1,000 shares

(100 percent) of the voting stock of Arba Investments, Inc., and

changed Arba's name to Cedilla Co.

IRA's consolidated return for 1978 reported consolidated net

losses of $18,673 and a net loss for Cedilla Investment Co. of

$605,992 and reflects the following income and end-of-year

balance sheets with respect to IRA and Cedilla Co.

(unconsolidated):
 - 107 -

IRA Cedilla Co.
Income
Gross receipts $777,499 $10,697
Dividends 20,572 --
Interest 38,885 18
Capital gain 69,715 --
Partnership 4,829 --
Total 911,500 10,715
Deductions
Compensation--officers 15,000 7,500
Salaries/wages 5,051 4,287
Consulting Fees 51,900 --
Commissions 207,237 --
Other 18,565 8,446
Total 297,753 20,233
Net income 613,747 (9,518)
Special deductions (16,910) --
Taxable income 596,837 (9,518)

Assets
Cash 28,600 70,996
Loans
Stockholders 287,900 --
Others 734,350 6,385
Securities
Marketable 318,197 --
Nonmarketable 215,000 --
Investment in sub. 34,024 --
Investment in pship. (180,703) --
Cedilla trust 4,511 --
Other 1,051 2,060
Total 1,442,930 79,441
Liabilities
Payables 70,000
Short term 197,575 --
Long term 370,000 --
Other 1,211 555
Total 568,786 70,555
Net assets 874,144 8,886
Capital stock
Preferred 1,000 --
Common 100 1,000
Capital surplus 18,024
Retained earnings 873,094 (10,138)
Cost of treasury stock (50)
 - 108 -

1979

Although IRA acquired 100 shares (100 percent) of KWJ Corp.

in November 1978, IRA first included KWJ Corp. on its 1979

consolidated return.24 During 1979, IRA sold its Schnitzer-PMS

stock back to Century Development. Schaffel's payments to IRA

began in 1979. Frey's arrangement began in 1979 and, in December

1979, IRA acquired 1,000 shares of Zeus Ventures, Inc. (Zeus).

IRA's consolidated return for 1979 reported a consolidated

net loss of $20,728, a net loss for Cedilla Investment Co. of

$320,425, and net taxable income from KWJ Corp. of $119,646 and

reflects the following income and end-of-year balance sheets with

respect to IRA and Cedilla Co. (unconsolidated):

24
IRA's 1978 return reported $1,442,930 total assets as of the
close of the year, $34,024 of which was the amount of its
investment in subsidiaries. The 1979 return reported $1,592,930
of total assets as of the beginning of the year, $184,024 of
which was the amount of its investment in subsidiaries. The
$150,000 difference is the amount IRA agreed to pay for the KWJ
Corp. stock.
 - 109 -

IRA Cedilla Co.
Income
Gross receipts $73,280 $101,274
Dividends 3,125 --
Interest 112,804 1,038
Gross rents 225 --
Capital gain 141,519 --
Partnership 1,157,861 --
Management fees -- 2,750
Consulting fees 100,000
Total 1,588,814 105,062
Deductions
Compensation--officers -- 26,800
Salaries/wages -- 4,100
Depreciation 638,550 --
Consulting fees 125,000 --
Commissions 209,440 --
Other 60,911 19,470
Total 1,033,901 50,370
Net income 554,913 54,692
Special deductions (2,055) --
Taxable income 542,858 54,692

Assets
Cash 962,964 11,806
Loans
Stockholders 1,200 --
Others 3,725,675 21,885
Treasury bills -- 24,308
Securities -- --
Marketable 177,951 --
Nonmarketable 65,000 --
Investment in sub. 234,024 --
Investment in pship. 130,907 1,800
Depreciable assets 5,108,573 --
Less accumulated dep. (638,550) --
Cedilla trust 4,511 --
Deferred expenses 91,640 --
Other 1,029 2,060
Total 9,864,924 61,859
Liabilities
Payables
Short term 309,795 --
Long term 5,319,924 --
Deferred income 2,807,260 --
Total 8,436,979 --
Net assets 1,427,945 61,859
Capital stock
 - 110 -

Preferred 1,000 --
Common 100 1,000
Capital surplus -- 18,024
Retained earnings 1,426,895 42,835
Cost of treasury stock (50) --

1980

In January 1980, IRA acquired 1,000 shares (100 percent) of

Brickell Enterprises, Inc. (Brickell).

IRA's consolidated return for 1980 reported consolidated

taxable income of $65,094, a net loss for Cedilla Investment Co.

of $145,887, net taxable income for Zeus of $118,269, a net loss

for KWJ Corp. of $2,620, and net taxable income from Brickell of

$90,225 and reflects the following income and end-of-year balance

sheets with respect to IRA and Cedilla Co. (unconsolidated):

IRA Cedilla Co.
Income
Dividends $15,467 --
Interest 578,031 $2,373
Gross rents 581,180 300
Capital gain 217,981 --
Partnerships 1,448,542 --
Commissions & fees 244,920 38,311
Total 3,086,121 40,984
 - 111 -

Deductions
Compensation--officers -- 19,800
Salaries/wages -- 6,918
Interest 916,507 --
Depreciation 2,115,376 2,294
Commissions/fees -- --
Other 14,226 33,705
Total 3,046,109 62,717
Net income 40,012 (21,733)
Special deductions (13,147) --
Taxable income 26,865 (21,733)

Assets
Cash 1,399,085 1,510
Trade receivables 703 --
Loans
Stockholders 1,200 --
Others 1,896,320 15,885
Installment receivable 2,738,532 --
Securities
Marketable 411,481 --
Nonmarketable 348,024 --
Investment in sub. -- --
Investment in pship. 326,072 --
Depreciable assets 12,468,476 22,937
Less accumulated dep. (2,753,926) (2,294)
Cedilla trust 4,511 --
Deferred expenses 91,640 --
Other 1,325 2,060
Total 16,933,443 40,098
Liabilities
Payables 118,756 --
Short term 606,000 --
Long term 12,258,949 --
Deferred gain 2,606,029 --
Other 2,869 --
Total 15,592,603 --
Net assets 1,340,840 40,098
Capital stock
Preferred 1,000 --
Common 100 1,000
Capital surplus 18,024
Retained earnings 1,339,740 21,074
 - 112 -

1981-82

During 1981, Essex Corp. and Gateway Corp. were organized.

In November 1981, IRA acquired 1,000 shares of IRA Florida

Apartments, Inc. (IRA Flor. Apts.). During 1982, the Essex

partnership was organized. During 1982, Ballard and Lisle

retired from Prudential; Lisle began employment with Travelers,

and Ballard began employment with Goldman-Sachs.

IRA's consolidated returns for 1981 and 1982 reported

consolidated net losses of $615,852 and $121,501, respectively,

which included a net loss of $25,057 in 1981 and net taxable

income of $72,407 for Cedilla Investment Co., net income of

$107,887 in 1981 and $448,691 in 1982 for Zeus, net income of

$91,118 in 1981 and $155,842 in 1982 for KWJ Corp., net income of

$5,954 in 1981 and a net loss of $19,184 in 1982 from Brickell,

and net losses of $6,568 in 1982 from IRA Florida Apts. and

reflects the following income and end-of-year balance sheets with

respect to IRA and Cedilla Co. (unconsolidated):
 - 113 -
1981 1982
IRA Cedilla Co. IRA Cedilla Co.
Income
Dividends $2,306 -- $333,611 –-
Interest 673,674 1,747 354,531 7,587
Gross rents 2,484,330 8,550 2,437,715 4,828
Capital gain 304,883 -- -- --
Partnerships 725,964 -- (483,219) --
Commissions 205,275 62,585 325,000 112,958
Parking income -- 823 -- --
Management fees -- 2,375 5,832 --
Other fees 156,250 -- 447,450 --
Miscellaneous 91 -- 1,514 478
Total 4,552,773 76,080 3,422,434 125,851
Deductions
Compensation--officers –- 26,300 -- --
Directors fees 12,500 -- -- --
Salaries/wages 9,969 9,361 26,079 9,231
Bad debts 395,600 -- 162,200 –-
Interest 2,164,579 -- 1,872,881 32
Depreciation 2,561,361 5,047 1,610,457 5,047
Consulting fees -- -- 29,000 --
Commissions 115,400 -- -- 66,776
Other 85,284 30,678 58,580 34,764
Total 5,344,693 71,386 3,759,197 115,850
Net Income (791,920) 4,694 (336,763) 10,001
NOL –- –- (793,880) --
Special deductions (1,960) -- (322,569) –-
Taxable income (793,880) 4,694 (1,453,212) 10,001

Assets
Cash 28,671 1,885 57,110 104
Money market 107,379 8,684 43,885 14,065
Receivables
Notes & accounts 2,429,224 -- 2,256,783 --
Rents 3,570 -- -- --
Loans
Stockholders 366,350 -- 340,930 --
Others 3,066,284 26,860 3,002,131 37,600
Securities
Short term 1,030,000 -- 1,460,000 --
Marketable 405,293 -- 492,663 --
Nonmarketable 200,700 -- 312,700 --
Investment in sub. 236,024 -- 268,924 --
Investment in pship. 2,607,473 -- 2,149,204 --
Depreciable assets 12,478,152 24,550 10,270,651 24,550
Less accumulated dep. (5,315,286) (7,341) (6,000,765) (12,388)
Other -- 447 1,190 1,380
Total 17,643,834 55,085 14,655,406 65,311
Liabilities
Short term notes 585,000 9,600 1,038,099 9,600
Long term notes 13,754,966 -- 11,259,516 --
Loan from stockholder 262,400 -- 2,400 --
Deferred gain 2,311,689 -- 2,147,594 --
Other -- 693 914 981
Total 16,914,055 10,293 14,448,523 10,581
Net assets 729,779 44,792 206,883 54,730
 - 114 -
Capital stock
Preferred 1,000 -- 1,000 --
Common 100 1,000 100 1,000
Capital surplus -- 18,024 –- 18,024
Retained earnings 728,679 25,768 205,783 35,706

1983

IRA reported that it liquidated Brickell, IRA Florida Apts.,

and KWJ Corp. under section 332 during 1983. In December 1983,

IRA acquired 1,000 shares (100 percent) of the common stock of

Carlco, TMT, and BWK, Inc.

IRA's 1983 consolidated return and adjusting journal entries

show that Schott's shares of IRA preferred stock were redeemed in

1983 in exchange for IRA's 1,000 shares of Cedilla Co. common

stock. IRA reported that its shares of Cedilla Co. were redeemed

for $1,000 in April 1983 and reported a long-term capital loss of

$18,024 on the sale. IRA's consolidated income also included a

$35,000 net operating loss from Cedilla Co. Cedilla Co. had no
 - 115 -

income and claimed a deduction of $35,000 for commission

expenses. Cedilla Co.'s 1983 adjusting journal entry indicates

that the $35,000 due to Schott was paid by offsetting amounts

owed by Schott to Cedilla Co.

IRA's consolidated return for 1983 reported a consolidated

net loss of $425,538, net income of $140,065 for Cedilla

Investment Co., net income of $149,128 for Zeus, net income of

$139,783 for KWJ Corp., a net loss of $21,567 from Brickell, and

a net loss of $18,356 from IRA Florida Apts. and reflects the

following income and end-of-year balance sheets with respect to

IRA (unconsolidated):

IRA
Income
Dividends $343,080
Interest 402,022
Gross rents 2,581,652
Capital gain 314,855
Partnerships (689,461)
Commissions
General fees 244,732
Consulting fees 26,000
Total 3,222,880
Deductions
Bad debts 22,075
Interest 1,834,892
Depreciation 1,636,137
Commissions/fees
Other 88,311
Total 3,581,415
Net Income (358,535)
NOL (1,453,212)
Special deductions (336,303)
Taxable Income (2,148,050)
 - 116 -

Assets
Cash 110,281
Pooled funds 38,250
Notes Receivable 2,070,128
Loans
Stockholders 292,260
Others 1,592,983
Securities
Short term 3,776,000
Marketable 564,827
Nonmarketable 192,700
Investment in sub. 83,000
Investment in pship. 1,640,284
Depreciable assets 11,286,020
Less accumulated dep. (7,636,902)
Other 2,365
Total 14,012,196
Liabilities
Payables
Short term 1,341,617
Long term 11,060,633
Deferred gain 1,969,973
Other
Total 14,372,223
Net assets (360,027)
Capital stock
Preferred
Common 100
Capital surplus
Retained earnings (360,127)
 - 117 -

1984-87

IRA distributed cash accumulated from Prudential

transactions, including cash received from Zeus and the

liquidation of KWJ Corp. and its interests in the Essex and

Sherwood partnerships, in the ratio of 45 percent each to Carlco

and TMT and 10 percent to BWK, Inc. Carlco, TMT, and BWK, Inc.,

contributed the Hyatt contract rights to a new partnership called

KWJ Co.

IRA's consolidated returns for 1984 to 1987 reported the

following consolidated net losses, net income or loss for Cedilla

Investment Co. and Zeus, and income for IRA, and reflect the

following end-of-year balance sheets with respect to IRA

(unconsolidated):
 - 118 -
1984 1985 1986 1987
Consolidated
income(loss) ($175,946) $96,363 ($327,854) ($16,942)
Cedilla Invest. 331,263 376,929 (1,148,003) (704,460)
Zeus (96,473) (153,108) (151,122) (181,747)
IRA
Income
Dividends 113,505 97,206 87,079 31,960
Interest 247,230 177,236 164,843 238,396
Gross rents 2,689,177 2,689,177 1,175,346 1,271
Capital gain 247,929 -- (62,833) 604,750
Partnerships 24,821 (202,702) 373,779 186,845
Loss notes -- -- -- (1,176,670)
Commissions/fees -- -- -- --
Other 356 1,000 (546) --
Total 3,323,018 2,761,917 1,737,668 (113,448)
Deductions
Bad debts -- -- -- 132,013
Interest 1,778,953 1,477,807 543,077 274
Depreciation 1,748,335 1,222,686 316,192 3,228
Consulting fees -- -- -- --
Commissions -- 4,000 -- --
Other 20,752 22,784 29,683 37,094
Total 3,548,040 2,727,277 888,952 172,609
Net income (225,022) 34,640 848,716 (286,057)
NOL (89,235) (410,736) (458,721) --
Special ded. (96,479) (82,625) (86,412) (31,960)
Taxable income (410,736) (458,721) 303,583 (318,017)

Assets
Cash 53,976 11,933 322,645 1,241,888
Pooled funds 38,250 -- -- --
Notes Receiv. 1,868,086 1,649,390 2,528,266 1,156,439
Loans
Stockholders 292,479 -- -- --
Subsidiaries -- 292,569 345,869 --
Others 1,543,454 1,146,668 1,186,973 620,594
Securities
Short term 422,000 415,000 -- --
Marketable 230,451 -- -- --
Nonmarketable 4,430,107 4,848,613 5,291,069 5,718,826
Invest. sub. 65,000 65,000 65,000 65,000
Invest. pship. 1,129,898 1,041,875 1,194,093 345,491
Deprec. assets 11,286,020 11,286,020 23,721 23,721
Less acc. dep. (9,385,237) (10,607,923) (20,494) (23,721)
Other 2,365 2,365 2,365 2,365)
Total 11,976,849 10,151,510 10,939,507 9,150,603
Liabilities
Payables -- -- -- --
Short term 81,250 122,925 45,490 45,490
Long term 11,258,179 9,995,705 9,495,319 9,495,280
Defer. gain 1,777,711 1,569,599 2,459,893 1,100,516
Other -- -- -- --
Total 13,117,140 11,688,229 12,000,702 10,641,286
Net assets (1,140,291) (1,536,719) (1,061,195) (1,490,683)
 - 119 -
Capital stock
Preferred -- -- -- --
Common 100 100 100 100
Capital surplus
Retained earn. (1,140,391) (1,536,819) (1,061,295) (1,490,783)

1988-89

In December 1988, IRA acquired 850 shares (85 percent) of

Decisions Holding Corp. in a section 351 exchange for all of its

shares of Cedilla Invest. and Zeus, plus $60,000.25 Zeus

continued to hold an $807,028 receivable from Holding Co. plus

$64,000 of receivables (exchanged during 1988 for a $64,000

receivable from HELO). No payments were made by Holding Co. or

the others on the receivables, and no efforts were ever made to

collect on the receivables.

25
On IRA's 1988 consolidated return, IRA reported that it
contributed $60,000 to Decisions Holding Corp. in the sec. 351
transaction in exchange for 85 percent of the stock of Decisions
Holding Corp. The return, however, also reported the transfers
of IRA's stock in Cedilla Invest. and Zeus to Decisions Holding
Corp. See infra Issue 23.
 - 120 -

IRA's consolidated returns for 1988 and 1989 reported

consolidated net losses, and net income or loss for Cedilla

Investment Co., Zeus, and Decisions Holding Corp. and reflected

the following income and end-of-year balance sheets with respect

to IRA (unconsolidated):

1988 1989
Consolidated income (loss) ($637,842) ($116,521)
Cedilla Invest.
Net 52,446 11,702
NOL (704,460) (652,014)
Taxable (652,014) (640,312)
Zeus
Net (163,987) (18,419)
NOL (181,747) (345,734)
Taxable (345,734) (364,153)
Decisions Holding Corp.
Net income (1,066,348) (3,394)
NOL (1,066,348)
Taxable income (1,066,348) (1,069,742)
IRA
Income
Dividends 65,093 --
Interest 180,828 120,555
Gross rents 188 --
Capital gain 293,593 780,343
Partnerships 106,970 110,087
Commissions/fees
Total 646,672 1,010,985
Deductions
Commissions/fees
Other 44,001 59,927
Total 44,001 59,927
Net income 602,671 951,058
NOL (311,625) (419,626)
Special deductions (52,074) --
Taxable income 238,972 531,432
 - 121 -

1988 1989
Assets
Cash $1,320,716 $611,752
Notes Receivable 879,079 --
Loans
Stockholders -- --
Others 554,969 1,309,744
Securities -- --
Marketable
Nonmarketable 6,145,610 6,806,346
Investment in sub. 125,000 125,000
Investment in pship. 390,091 478,847
Other 2,365 2,365
Total 9,417,830 9,334,054
Liabilities
Payables/notes
Short term -- --
Long term 9,495,280 9,495,280
Deferred gain 836,581 --
Other
Total 10,331,861 9,495,280
Net assets (914,031) (161,226)
Capital stock
Preferred -- --
Common 100 100
Capital surplus
Retained earnings (914,131) (161,326)

IRA's records show the following assets (unconsolidated) for

the years 1983 through 1989:
 - 122 -
IRA Assets 1983 1984 1985 1986 1987 1988 1989
Cash and CD's
Amer. Natl Bank $58,322 $2,047 -- -- –- –- (8,248)
Skylark Bank 49,966 49,966 -- -- -- -- --
Perinne Bank 1,993 1,963 -- -- -- -- --
Administration Co. 38,250 38,250 -- -- -- -- --
CD's 3,776,000 422,000 415,000 -- 915,000 998,051 620,000
Special E –- -- 11,933 322,645 -- -- --
Principal Services -- –- -- -- 326,888 322,665 --
Total 3,924,531 514,226 426,933 322,645 1,241,888 1,320,716 611,752
Notes Rec.
PMS Note 2,070,128 1,868,086 1,649,390 1,412,666 1,156,439 879,079 --
Aura -- -- 175 –- –- –- --
Kanter –- –- 16,612 –- -- -- 600,000
Funding Sys. 183,750 122,500 –- –- –- –- --
The Holding Co. 5,027 -– 45,000 64,000 76,743 76,743 76,743
Int'l Films 532,420 535,520 504,548 507,648 -- -- --
HELO 510,100 502,100 495,500 485,825 -- -- --
Tanglewood 350,000 350,000 –- -– –- -- --
Cedilla Invst. 292,260 292,479 292,569 345,869 -- –- --
B. DiLanciano 3,334 3,334 3,334 –- –- -- --
Larry Freeman 8,351 –- –- –- –- –- --
KWJ Co. –- 30,000 75,500 113,500 161,500 181,500 249,870
Landing -- -– 6,000 –- -- -- --
Forest Activity -- -- –- 16,000 -- -- --
Hyatt Corp. -- -- –- 1,115,560 -- -- --
Cablevision Sys. -- -- -- –- 181,247 90,624 --
Bea Ritch Trust -- -- -- –- 200,000 200,000 200,000
MAF, Inc. -- -- -- -- 1,002 -- --
CMB Cin. Vent. -- -- -- -- 102 102 102
RWL Cin. Trust -- -- -- -– -- 6,000 6,000
Decisions Holding -- -- -- -- -- -- 400
Carlco -- -- -- -- -- -- 122,355
TMT –- –- –- –- –- –- 54,274
Total 3,955,370 3,704,019 3,088,628 4,061,068 1,777,033 1,434,048 1,309,744
 - 123 -
IRA Assets 1983 1984 1985 1986 1987 1988 1989
Invest. in Stocks
Newell $14,535 -- -- -- -- -- --
Marmom Group 284,009 -- -- -- -- -- --
Micro Z 74,200 -- -- -- -- -- --
Enterp. Tech. 10,664 -- -- -- -- -- --
Composit Cont. 115,000 $115,000 -- -- -- -- --
Modular Pwr. 12,200 12,200 -- -- -- -- --
Greenwich Pharm. 9,219 -- -- -- -- -- --
Funds for Energy 45,000 45,000 -- -- -- -- --
Int'l Films 65,000 65,000 $65,000 $65,000 -- -- --
Cedilla Invst. 15,000 15,000 15,000 15,000 $15,000 -- --
Zeus 50,000 50,000 50,000 50,000 50,000 -- --
Walnut Capital 40,000 40,000 40,000 40,000 80,000 $80,000 $80,000
Geocham 87,700 87,700 -- -- -- -- --
Carlco 6,000 1,856,942 2,040,992 2,203,362 2,395,676 2,558,437 2,936,627
BWK 6,000 417,321 458,221 494,303 530,473 566,642 650,684
TMT 6,000 1,962,144 2,243,400 2,488,403 2,712,677 2,940,531 3,139,035
Brajdas -- 58,251 -- -- -- -- --
Hyatt Air -- 1,000 1,000 -- -- -- --
Decision Holdings –- -- -- -- -- 125,000 125,000
Total 840,527 4,725,558 4,913,613 5,356,068 5,783,826 6,270,610 6,931,346
Partnerships
Micro Z 26,191 28,387 30,104 31,059 31,059 30,041 30,032
Brickell Biscayne 135,245 160,559 169,885 180,205 -- -- --
TicketMaster 39,631 39,624 39,617 39,615 39,615 -- --
Polar 1,181,470 879,177 576,587 274,069 (3,269) (3,356) (3,356)
May Invest (2,559) (388) (231) (663) 1,138 (2,298) (2,439)
Sandburg Village 650,975 656,929 643,088 581,006 -- -- --
UP Associates (211,287) (329,185) (447,419) (449,561) (542,452) (542,489) (542,803)
Essex 45,283 -- -- -- -- -- --
Sherwood (51,742) -- -- -- -- -- --
Chicago Cablevision (90,375) (156,319) (224,202) (292,880) (337,678) (364,038) (384,914)
Cablevision Prog. (82,547) (148,886) 254,446 -- -- -- --
HICIP -- -- -- 831,243 1,157,078 1,272,231 1,382,327
Total 1,640,285 1,129,898 1,041,875 1,194,093 345,491 390,091 478,847
Rental property
Cost 11,262,299 11,262,299 11,262,299 -- -- -- --
Accum. dep. (7,628,162) (9,371,728) (10,590,882) –- –- –- --
Total 3,634,137 1,890,571 671,417 –- –- –- --
Other total 17,346 12,577 9,045 5,592 2,365 2,365 2,365
 - 124 -
Total assets 14,012,196 11,976,849 10,151,511 10,939,466
9,150,603 9,417,830 9,334,054
IRA and its subsidiaries' consolidated total income, taxable

income, net operating losses, and taxes paid for the years 1978

through 1989 were as follows:

Total Taxable Net
Year Income Income Operating Losses Tax Paid
1978 $1,004,475 ($18,673) ($27,394) --
1979 1,944,332 404,771 (18,673) $94,618
1980 3,557,198 65,094 -- --
1981 5,158,583 (615,852) -- --
1982 4,536,122 (121,501) (143,987) --
1983 3,849,742 (435,535) (121,501) --
1984 3,606,785 (175,964) (89,235) --
1985 3,118,893 96,363 (175,946) --
1986 2,345,762 (328,854) -- --
1987 299,794 (16,942) (111,843) --
1988 (526,393) (637,842) (10,550) --
1989 1,011,577 (116,521) (1,057,468) 10,819

IRA and its subsidiaries’ consolidated total income, rental

income, and difference for the years 1978 through 1989 were as

follows:

Total Rental
Year Income Income Difference
1978 $1,004,475 $241,072 $ 763,403
1979 1,944,332 242,818 1,701,514
1980 3,557,198 831,264 2,725,934
1981 5,158,583 2,740,082 2,418,501
1982 4,536,122 2,681,385 1,854,737
1983 3,849,742 2,820,494 1,029,248
1984 3,606,785 2,928,019 678,766
1985 3,118,893 2,928,019 190,874
1986 2,345,762 1,627,094 718,668
1987 299,794 9,940 298,854
1988 (526,393) 188 (526,205)
1989 $1,011,577 -- 1,011,577
 - 125 -

On the consolidated returns, IRA reported that it paid (not

including payments by subsidiaries) the following compensation of

officers, compensation of directors, salaries and wages,

commissions, and consulting fees for the years 1976 through 1989:

Year Officers Directors Wages Commissions Consulting
1976 -- -- -- $213,333 --
1977 $19,300 -- $986 12,000 --
1978 15,000 -- 5,051 207,237 $51,900
1979 -- -- -- 209,440 125,000
1980 -- -- -- -- --
1981 -- $12,500 9,969 115,400 --
1982 -- -- 26,079 -- 29,000
1983 -- -- -- -- --
1984 -- -- -- -- --
1985 -- -- -- 4,000 --
1986 -- -- -- -- --
1987 -- -- -- -- --
1988 -- -- -- -- --
1989 -- -- -- -- --

H. Changes in Holding Co. & Subsidiaries Corporate Structure
12/76 Through 8/87

Holding Co. was incorporated on December 8, 1976.

Holding Co.'s return for the fiscal year ending August 31, 1978,

indicates that Kanter owned 75 percent of Holding Co.'s voting

stock as of the close of the taxable year. The return indicates

that preferred shares as well as common shares of stock were

outstanding at that time.
 - 126 -

12/76 Through 8/31/77

By August 31, 1977, Holding Co. had acquired Citra Co.

(Citra).

9/1/77 Through 8/31/78

On November 25, 1977, Holding Co. had acquired 1,000 shares

(100 percent) of the common stock (no preferred stock was issued)

of The Active Business Corp. (Active). On July 21, 1978, Active

acquired 500 shares (100 percent) of the voting stock of Harbor

Investments, Inc., which later changed its name to Harbor

Exchange Lending Operation (HELO).
 - 127 -

9/1/78 Through 8/31/79

On May 22, 1979, Holding Co. acquired 1,000 shares (100

percent) of the voting stock of Oil Investments, Ltd. (Oil

Investments).
 - 128 -

9/1/79 Through 8/31/80

Holding Co. acquired 1,000 shares (100 percent) of the

voting stock of The Nominee Corp. (Nominee) on January 7, 1980,

and 100 shares (100 percent) of the voting stock of Tanglewood

Properties, Inc., on April 30, 1980. Harbor Investments changed

its name to Harbor Exchange Lending Operations (HELO) between

September 1, 1979, and August 31, 1980.

9/1/80 Through 8/31/81

Holding Co. acquired the voting stock of L.B.G. Properties,

Inc. (LBG Prop.), in November 1980, Zion in December 1980, and

Twilight Properties, Inc. (Twilight), in April 1981.
 - 129 -

9/1/81 Through 8/31/83

Between August 31, 1981, and August 31, 1983, Holding Co.

acquired 100 percent of the voting shares of Columbus Projects,

Inc. (Columbus), PPPD, Inc. (PPPD), and PPPI, Inc. (PPPI). In

1981 Frey began making payments to Zion, and in 1982 Essex began

making payments to Holding Co.
 - 130 -

9/1/83 Through 8/31/84

In 1984, Schaffel began making payments to Holding Co. On

August 31, 1984, Holding Co. sold or liquidated all of its stock

in Active, Citra, Columbus, HELO, PPPD, and PPPI.
 - 131 -

9/1/84 Through 8/31/85

On August 31, 1985, Holding Co. sold or liquidated its stock

in Nominee. It reacquired the stock in Nominee on September 1,

1986.

I. Holding Co. & Subsidiaries Returns

The consolidated returns of Holding Co. and its subsidiaries

show the following with respect to taxable years ending July 31,

1977 to 1987:
 - 132 -
8/31/77 8/31/78 8/31/79 8/31/80 8/31/81
Income(loss)
Consolidated
Income -- $594,653 $900,572 $1,076,933 $1,110,335
Deductions -- (613,972) (813,324) (939,205) (3,828,869)
Net -- (19,319) 87,248 137,728 (2,718,534)
NOL & Special -- (112,776) (160,468) (99,377) (80,124)
Taxable -- (132,095) (73,220) 38,351 (2,798,658)
Active
(acq. 11/77)
Income -- 59,961 28,387 49,902 23,768
Deductions -- (1,106) (3,468) (5,863) (4,381)
Net -- 58,855 14,919 44,039 19,387
NOL -- -- (1,658) -- –-
Taxable -- 58,855 13,261 44,039 19,387
Citra
Income -- 19,327 82 6 --
Deductions -- (335) (211) (1,221) (20)
Net -- 18,992 (129) (1,215) (20)
NOL -- -- -- (129) (1,344)
Taxable -- 18,992 (129) (1,344) (1,364)
HELO
(acq. 7/78)
Income -- -- -- 1,485 4,597
Deductions -- -- (115) (31,309) (149,974)
Net -- -- (115) (29,824) (145,377)
NOL -- -- -- (115) (29,939)
Taxable -- -- (115) (29,939) (175,316)
Nominee
Income -- -- -- -- --
Deductions -- -- -- (31) (1,589)
Net -- -- -- (31) (1,589)
NOL -- -- -- (31)
Taxable -- –- -- (31) (1,620)
Oil Investments
Income -- -- -- (444,493) (619,431)
Deductions -- -- (54) (28,227) (5,637)
Net -- -- (54) (472,720) (625,068)
NOL -- -- -- (54) (472,774)
Taxable -- -- (54) (472,774) (1,097,842)
 - 133 -
8/31/77 8/31/78 8/31/79 8/31/80 8/31/81
Tanglewood
Income -- -- -- $246,059 $818,591
Deductions -- -- -- (241,573) (1,122,339)
Net -- -- -- 4,486 (303,748)
NOL -- -- -- -- –-
Taxable -- -- -- 4,486 (303,748)
Holding Co.
Income
Dividends -- $118,940 $35,069 30,773 78,130
Interest -- 284,413 449,889 182,802 80,077
Gross rents -- 182,357 264,538 264,338 264,938
Capital Gain -- (35,277) 272,693
Partnerships -- (118,638) 58,819 (240,878) (405,693)
Commissions -- 92,792 63,788 75,000 344,175
Consulting fees -- -- -- -- 150,000
Condo conversion -- -- -- 579,394 --
Other 59,852 --
Total 524,587 872,103 1,223,974 511,627
Deductions
Bad debts -- -- -- -- 799,552
Interest -- 176,936 477,517 372,691 1,160,279
Depreciation -- 442,276 315,911 225,651 161,179
Commissions
Consulting -- -- -- 15,000 600
Legal & profess. -- -- 5,796 15,297 2,689
Other -- 2,541 252 2,342 14,192
Total -- 621,753 799,476 630,981 2,138,491
Net Income -- (97,166) 72,627 592,993 (1,626,864)
NOL –- -- (209,008) (166,190) --
Special ded. -- (112,776) (29,809) (26,157) (66,950)
Taxable Income -- (209,942) (166,190) 400,646 (1,693,814)
Holding Co.
Assets -- -- -- -- --
Cash 27,199 3,012 (14,850) 31,613 (590,353)
Dividends receiv. -- 77,847 -- -- --
Mortgage Loan -- 94,479 14,479 -- --
Loans
Stockholders 161,500 197,638 40,316 -- --
Subsidiaries
Others 2,371,000 5,325,153 12,188,227 15,378,662 4,228,168
 - 134 -
8/31/77 8/31/78 8/31/79 8/31/80 8/31/81
Securities
Marketable $263,887 $2,177,889 $1,299,799 $2,076,472 $235,609
Nonmarketable 34,956 99,888 207,139 511,042 455,828
Invest. sub. 50,000 100,000 178,849 180,849 194,447
Invest. pship. 70,890 82,406 350,033 42,755 263,305
Deprec. assets -- 1,547,966 1,547,966 1,547,966 1,547,966
Less acc. dep. -- (442,276) (758,187) (983,838) (1,145,017)
Land -- -- -- 5,000 5,000
Other 9,899 3,039 2,999 4,103 3,170
Total 2,989,331 9,267,041 15,056,770 18,794,624 5,198,123
Liabilities
Loans/notes
Short-term 550,000 833,758 1,142,616 579,246 2,546,566
Long-term 2,269,000 6,743,486 13,150,752 16,528,988 1,352,085
Stockholder 45,000 138,000 -- 126,431 334,983
Subscription -- -- 45,000 45,000 53,000
Due broker -- 1,068,091 363,498 567,487 651,595
Other 86,314 131,946 -- -- 969
Total 2,950,314 8,915,281 14,701,866 17,847,152 4,939,198
Net assets 39,017 351,760 354,904 947,472 258,925
Capital stock
Preferred 275 50,778 50,778 50,778 1,550,778
Common 2 23 23 23 23
Capital surplus 49,723 407,086 407,086 407,086 407,086
Retained earn. (10,983) (106,127) (102,983) 489,585 (1,698,962)
HELO
Assets
Cash -- -- 231 4,294 (879,704)
Pooled funds -- -- -- 718 --
Loans receiv. -- -- -- -- --
Others -- -- -- 2,871,082 4,691,912
Other -- 500 151 120 348
Total 500 382 2,876,214 3,812,556
Liabilities
Payables -- -- -- -- --
Short-term -- -- -- 322,987 849,680
Long-term -- -- -- 1,327,100 3,127,200
Shareholder -- -- -- 1,255,600 10,557
Total -- -- -- 2,905,687 3,987,437
Net assets -- 500 382 (29,473) (174,881)
 - 135 -
8/31/77 8/31/78 8/31/79 8/31/80 8/31/81
Capital stock
Preferred -- -- -- -- --
Common -- 500 500 500 500
Capital surplus -- -- -- -- --
Retained earn. -- -- (118) (29,973) (175,381)

8/31/83 8/31/84 8/31/85 8/31/86 8/31/87
Income(loss)
Consolidated
Income -- 2,747,847 5,453,080 2,103,200 607,736
Deductions -- (3,982,819) (4,028,682) (1,824,013) (1,118,480)
Net -- (1,234,972) 1,424,398 279,187 (510,744)
NOL & special -- (6,317,893) (7,355,261) (5,932,002) (5,655,428)
Taxable (6,316,713) (7,552,865) (5,930,863) (5,652,815) (6,166,172)
Active
Income -- (22,311) -- -- --
Deductions -- (71,467) -- -- --
Net -- (93,778) -- -- --
NOL -- (1,648,466) -- -- --
Taxable (1,648,466) (1,742,244) -- -- --
Citra
Income -- 60 -- -- --
Deductions -- (699) -- -- --
Net -- (639) -- -- --
NOL -- -- -- -- --
Taxable (639) (639) -- -- --
Columbus Projects
Income -- (41,684) -- -- --
Deductions -- (169) -- -- --
Net -- (41,853) -- -- --
NOL -- (70,273) –- -- --
Taxable (70,273) (112,126) -- -- --
HELO
Income -- 136 -- -- --
Deductions -- (30) -- -- --
Net -- 106 -- -- --
NOL -- (198,135) -- -- --
Taxable (198,135) (198,029) -- -- –-
 - 136 -
8/31/83 8/31/84 8/31/85 8/31/86 8/31/87
LBG Properties
Income -- 257,663 219,000 382,823 300,000
Deductions -- (277,218) (219,062) (461,384) (300,067)
Net -- (19,555) (62) (78,561) (67)
NOL -- (273,136) (292,691) (292,753) (371,314)
Taxable (273,136) (292,691) (292,753) (371,314) (371,381)
Nominee
Income -- -- 52 -- --
Deductions -- (618) (290) -- (80)
Net -- (618) (238) -- (80)
NOL -- (512) (1,130) -- (1,371)
Taxable (512) (1,130) (1,368) -- (1,451)
Oil Investments
Income -- (81,457) 8,088 (121,884) 11,981
Deductions -- (430) (11,623) (3,689) (291)
Net -- (81,887) (3,535) (125,573) 11,690
NOL -- (1,652,325) (1,734,212) (1,737,747) (1,863,320)
Taxable (1,652,325) (1,734,212) (1,737,747) (1,863,320) (1,851,630)
PPPD, Inc.
Income -- -- -- -- --
Deductions -- (375) -- -- --
Net -- (375) -- -- --
NOL -- (292) -- -- --
Taxable (292) (667) -- -- --
PPPI, Inc.
Income -- -- -- -- --
Deductions -- (365) -- -- --
Net -- (365) -- -- --
NOL -- (283) -- -- --
Taxable (283) (648) -- -- --
Tanglewood
Income -- 836,977 313,280 290,446 196,544
Deductions -- (763,046) (322,830) (462,098) (184,525)
Net -- 73,931 (9,550) (171,652) 12,019
NOL -- (260,287) (186,356) (195,906) (367,558)
Taxable (260,287) (186,356) (195,906) (367,558) (355,539)
 - 137 -
8/31/83 8/31/84 8/31/85 8/31/86 8/31/87
Twilight Prop.
Income -- 1,336,393 3,531,431 45,893 --
Deductions -- (2,334,351) (2,537,970) (260,027) --
Net -- (997,958) 993,461 (214,134) --
NOL -- (2,316,873) (3,314,831) (2,321,370) (2,535,504)
Taxable (2,316,873) (3,314,831) (2,321,370) (2,535,504) (2,535,504)
Zion
Income -- (93,233) (262,786) (315,749) (84,538)
Deductions -- (396) (354) (1,120) (120)
Net -- (93,629) (263,140) (316,869) (84,658)
NOL -- (216,308) (309,937) (573,077) (889,946)
Taxable (216,308) (309,937) (573,077) (889,946) (974,604)
Holding Co.
Income
Dividends -- 1,388 500 2,949 3,266
Interest -- 60,937 75,996 175,522 145,483
Gross rents -- 262,138 262,138 129,200 18,400
Capital gain -- 487,794 821,186 (229,447) (32,398)
Partnerships -- (343,048) (352,711) (219,551) (630,754)
Commissions -- 14,341 266,650 1,100,000 --
Other fees -- 69,496 414,036 441,723 588,796
Condo conversion -- -- -- --
Other -- 2,257 156,220 -- (498)
Total -- 555,303 1,644,015 1,400,396 92,295
Deductions
Bad debts -- -- 30,000 45,000 --
Interest -- 68,129 146,076 141,905 --
Depreciation -- 135,847 8,511 21,167 --
Commissions/fees -- 875 600,000 175,000 --
Legal & profess. -- 302,900 116,492 222,678 --
Other -- 25,904 35,474 29,945 --
Total -- 533,655 936,553 635,695 633,397
Net Income -- 21,648 707,462 764,701 (541,102)
 - 138 -
8/31/83 8/31/84 8/31/85 8/31/86 8/31/87
NOL -- -- -- (1,149,287) (387,093)
Active -- -- (1,742,244) -- --
Citra -- -- (639) -- --
Columbus Proj. -- -- (112,126) -- --
PPPD -- -- (667) -- --
PPPI -- -- (648) -- --
Special ded. -- (1,180) (425) (2,507) (2,613)
Taxable income -- (20,468) (1,149,287) (387,093) (930,808)
Holding Co.
Assets
Cash 103,880 215,579 190,832 129,934 (396,758)
Pooled funds 18,882 119,338 677,730 1,127,458 1,048,386
CD -- -- -- 1,060,000 970,500
Loans -- -- -- -- --
Stockholders 111,301 19,785 19,785 975,000 700,000
Others 5,219,398 4,023,564 4,476,787 2,218,852 4,490,268
Securities
Marketable 788,807 1,351,225 1,712,093 358,991 198,991
Nonmarketable 336,451 276,075 227,735 234,402 235,903
Invest. sub. 223,932 36,060 36,060 25,060 36,060
Invest. pship. (1,509,414) (3,628,091) (4,429,619) (4,191,984) (4,608,659)
Condominiums -- -- -- 250,484 250,484
Deprec. assets 1,549,027 1,557,732 1,844,476 1,844,476 251,051
Less acc. dep. (1,413,981) (1,549,828) (1,558,338) (1,579,505) (45,753)
Other 2,910 2,910 9,743 11,603 133,723
Total 5,431,193 2,424,349 3,207,284 2,464,771 3,264,196
Liabilities
Loans/notes -- -- -- -- –-
Short-term 2,046,772 1,404,904 1,484,337 –- --
Long-term 923,529 991,950 1,045,743 -- --
Stockholder 425,528 33,620 -- -- --
Deferred income 26,238 11,554 11,554 -- --
Other 49,750 4,750 4,750 –- --
Total 3,471,817 2,446,778 2,546,384 -- --
Net assets 1,959,376 (22,429) 660,900 -- --
Capital stock
Preferred 50,780 50,780 -- -- --
Common 23 23 -- -- --
Capital surplus 1,907,085 1,907,085 -- -- --
Retained earn. 1,488 (1,980,317) -- -- –-
 - 139 -
8/31/83 8/31/84 8/31/85 8/31/86 8/31/87
HELO
Assets -- -- -- -- --
Cash 31 322 -- -- --
Pooled funds -- 4,636 -- -- --
Loans Receiv. 2,331,326 1,320,059 -- -- --
Other assets 27 -- -- -- --
Total 2,331,384 1,325,017 -- -- --
Liabilities
Payables
Short-term 2,518,589 -- -- -- --
Long-term 10,557 1,522,700 -- -- --
Total 2,529,146 1,522,700 -- -- --
Net assets (197,762) (197,683) -- -- --
Capital stock
Preferred -- -- -- -- --
Common 500 500 -- -- --
Capital surplus
Retained earn. (198,262) (198,183) -- -- --
Zion
Assets
Cash (84) 7 55 9,719 9,094
Pooled funds -- 2,818 7,100 -- --
Marketable sec. -- 127,280 127,280 65,695 --
Invest. pship. 840,362 618,059 344,295 85,912 57,306
Other 5,345 2,524 -- -- --
Total 845,623 750,688 478,730 161,326 66,400
Liabilities
Loans/notes
Short-term 9,264 3,014 -- -- --
Long-term 104,694 104,694 99,871 -- --
Stockholder 629,650 636,000 636,000 636,000 --
Other -– -- -- 99,336 --
Total 743,608 743,708 735,871 735,336 725,801
Net assets 102,015 6,980 (257,141) (574,010) (659,401)
Capital stock
Preferred 8,000 8,000 8,000 8,000 8,000
Common 100 100 100 100 100
Capital surplus 133,250 133,250 133,250 133,250 133,250
Retained earn. (39,335) (134,370) (398,491) (715,360) (800,751)
 - 140 -

J. HELO 1979 Through 1983

Holding Co.'s consolidated returns reflect the following

income (all interest), deductions, net assets, and stockholder

equity with respect to HELO:

08/78 08/79 08/80 08/81 08/83 08/84

Interest $-0- $1,485 $4,597 N/A $136
Deductions (115) (31,309) (149,974) (30)
Total (115) (29,824) (145,377) 106
NOL (115) (29,939) (198,135)
Taxable (115) (29,939) (175,316) (198,029)

Assets
Cash $500 131 4,294 (879,704) $31 322
Receivables 2,871,082 4,691,912 2,331,326 1,320,059
Money market 718 259
Pooled funds 4,636
Intangibles 151 120 89 27
Total 500 382 2,876,214 3,812,556 2,331,384 1,325,017
Liabilities
Loans
Short-term 322,987 849,680 2,518,589 1,522,700
Shareholder 1,255,600 10,557
Long-term 1,327,100 3,127,200 10,557
Total -0- -0- 2,905,687 3,987,437 2,529,146 1,522,700

Net assets 500 382 (29,473) (174,881) (197,762) (197,683)

Capital stock 500 500 500 500 500 500
Retained (118) (29,973) (175,381) (198,262) (198,183)
earnings
 - 141 -

IV. Flow of Money

A. Payments to IRA and Subsidiaries: The Prudential
Transactions

1. Overview

The payments related to the Prudential transactions paid by

the Five to IRA and its subsidiaries during the years 1977

through 1989, were as follows:

Schnitzer
Year Hyatt1 Schaffel Frey PMS Essex Total

1977 $38,394 $38,394
1978 42,517 42,517
1979 119,719 $100,000 $303,088 522,807
1980 244,920 $127,372 380,337 752,629
1981 90,070 361,525 105,764 534,696 1,092,055
1982 172,702 447,450 538,781 361,692 $86,212 1,606,837
1983 172,090 30,981 110,125 361,692 78,376 753,264
1984 186,092 103,500 361,692 133,238 784,522
1985 206,790 128,763 361,692 120,175 817,420
1986 231,263 361,692 80,466 673,421
1987 229,449 361,692 120,698 711,839
1988 197,348 361,692 117,563 676,603
1989 52,777 840,423 51,727 944,927
Total 1,739,211 1,184,876 1,114,305 4,590,388 788,455 $9,417,235
1
Net Weaver's 30%.

Prior to 1984, all payments related to the Prudential

transactions were paid to IRA or one of its subsidiaries. By

early 1982, Ballard and Lisle had left Prudential. During 1982

Carlco, TMT, and BWK, Inc. were formed. In 1983 the three

corporations became part of IRA's consolidated group, KWJ Corp.

was liquidated, and the funds accumulated by Zeus were

distributed to IRA. In 1984, IRA distributed the funds that had

been accumulated from the Prudential transactions in the ratio of

45 percent to Carlco, 45 percent to TMT, and 10 percent to BWK,

Inc. From 1984 through 1989, most payments related to the
 - 142 -

Prudential transactions were paid to or distributed to Carlco,

TMT, and BWK, Inc.

2. Flow of the Funds 1977 Through 1983

The following diagram shows the money paid by the Five to

IRA, Zeus, and KWJ Corp. from 1977 through 1983 with respect to

the Prudential transactions:

1977-1983

Prior to 1984, all payments by the Five in connection with

the Prudential transactions were reported on the consolidated

returns of IRA. No tax was paid on this income because, during

the years 1978 through 1983, IRA reported substantial net

operating losses. IRA reported the following consolidated total

income, taxable income, and net operating losses for the years

1978 through 1983:
 - 143 -

Year Total Income Taxable Income Net Operating Losses
1978 $1,004,475 ($18,673) ($271,394)
1979 1,944,332 404,771 (18,673)
1980 3,557,198 65,094 --
1981 5,158,583 (615,852) --
1982 4,536,122 (121,501) (143,987)
1983 3,849,742 (435,535) (121,501)

a. Flow of Money From KWJ Corp. to IRA: 1978 Through 1983

IRA acquired all of KWJ Corp.'s stock from Weaver in 1979.

At the time of the purchase, KWJ Corp. had net assets of

$115,084. IRA's consolidated returns from 1979 through 1983

reported the following income, net assets, and stockholder equity

with respect to KWJ Corp.:
 - 144 -

1978 1979 1980 1981 1982 1983 Total
Income
Commission -- $171,027 -- $128,671 $246,717 $245,843 $792,258
Interest -- 703 -- 2,512 6,237 4,356 13,808
Total -- 171,730 -- 131,183 252,954 250,199 806,066
Deductions -- -- -- -- -- -- --
Commission -- 51,308 -- 38,601 74,015 73,753 237,677
Consulting -- -- -- -- 21,000 36,000 57,000
Other -- 776 $2,620 1,464 2,097 663 7,620
Total -- 52,084 2,620 40,065 97,112 110,416 302,297
Net Income -- 119,646 (2,620) 91,118 155,842 139,783 503,769

Assets $40,626 -- -- -- -- -- --
Cash 108,521 3,095 503 1,828 79,950 -- --
Accrued income -- 171,000 -- -- -- -- --
Pool funds -- -- -- -- 76,720 -- --
Loans
Stockholders(IRA) -- 171,000 262,400 2,400 -- --
Others -- 66,241 66,241 -- -- -- --
Total 149,147 $240,364 237,744 264,228 159,070 -- --
Liabilities 34,063 65,634 65,634 1,000 -- --
Net assets 115,084 174,730 172,110 263,228 159,070 -- --
-- -- -- -- -- -- --
Capital stock 1,000 1,000 1,000 1,000 1,000 -- --
Capital surplus -- -- -- -- -- -- --
Retained earnings 114,084 173,730 171,110 262,228 158,070 298,853 --

Distributions -- 60,000 -- -- 260,000 – –
 - 145 -

KWJ Corp. paid Weaver a total of $237,677 as commissions

from 1979 through 1983. KWJ Corp. paid $21,000 as consulting

fees to unidentified payees during 1982. KWJ Corp. paid three of

Ballard's and Lisle's children (Melinda Ballard, Thomas Lisle,

and Amy Albrecht) $1,000 each month during 1983 and deducted the

$36,000 as consulting expenses for 1983. KWJ Corp. had a total

of $7,620 in other expenses from 1979 through 1983.

In 1979, KWJ Corp. distributed $60,000 to IRA. During 1981

KWJ Corp. distributed $262,400 to IRA that was treated as a loan

from KWJ Corp. to IRA. In 1982, an offset of $260,000 of the

loan was treated as a dividend distribution to IRA. In 1983, IRA

repaid the remaining $2,400 loan. During 1983, KWJ Corp. was

liquidated, and $298,853 was distributed to IRA.

From 1979 through 1983, KWJ Corp. had available or received

a total of $921,150 from the following sources:
 - 146 -

KWJ Corp. distributed the $921,150 as follows:

b. Flow of Money From Zeus: 1979 Through 1983

In 1979, IRA organized Zeus and acquired all the common

stock for $50,000. The $50,000 paid by IRA for the stock was

recorded on the books as $100 for the common stock and $49,900 as

paid in capital. IRA also lent Zeus $50,000. In 1979, Zeus

purchased a 6.14-percent interest in Village of Kings Creek

(Frey's first condominium conversion project) for $100,000.

The Frey corporation paid the following amounts to Zeus

during the years 1980 through 1983:

Year Payment
1980 $127,372
1981 105,764
1982 538,781
1983 110,125
Total $882,042

All of Zeus' income from its incorporation through 1983 is

attributable to the payments from the Frey corporation, interest

income, and partnerships (including Frey condominium partnership,

the Village of Kings Creek, and the Greens). IRA's consolidated

returns for 1979 through 1983 reported the following income, net

assets, and stockholder equity with respect to Zeus:
 - 147 -
1979 1980 1981 1982 1983

Income
Interest -- -- -- $64,688 $55,104
Commission -- $127,372 $64,574 538,781 110,125
Partnership -- -- 2,382 (150,907) (15,049)
Other fees -- -- 32,567 -- --
Misc. -- -- 8,625 12 --
Total income -- 127,372 108,148 452,574 150,180
Deductions -- 9,103 261 3,883 1,052
Taxable -- 118,269 107,887 448,691 149,128
Nontaxable -- -- -- -- --
Partnership -- 6,828 -- (27,061) (753)

Assets
Cash -- 393 27,990 284 7,832
Loan receiv. -- -- 64,000 64,000 866,000
Securities -- -- -- 685,000 --
Money market -- -- 69,002 -- --
Partnerships $100,000 234,200 172,896 (5,073) (20,875)
Pooled funds -- -- -- 11,339 --
Intangibles -- 128 96 64 32
Total 100,000 234,721 333,984 755,614 852,989
Liabilities 50,000 59,624 51,000 51,000 --
Net assets 50,000 175,097 282,984 704,614 852,989

Capital stock 100 100 100 100 100
Capital -- -- -- -- --
surplus 49,900 49,900 49,900 49,900 49,900
Retained -- -- -- -- --
earnings 125,097 232,984 654,614 802,989

The $50,000 liability in 1979 and $51,000 of the liabilities

reflected on the balance sheet from 1980 through 1982 represented

loans outstanding from IRA to Zeus. The $64,000 loan receivable

is shown on Zeus' general ledger for 1984 as owed to Zeus by

Holding Co.'s subsidiary HELO.

At the close of 1982, Zeus had liquid assets of $696,623

($284 cash, $685,000 money market funds, and $11,339 in pooled

funds). During 1983 Zeus received cash income of $165,229

($55,104 interest and $110,125 commissions) and had cash
 - 148 -

expenditures of $1,020 ($1,052 deductions less $32 for

capitalized organizational expenses). Thus, during 1983, Zeus

had $860,832 in liquid assets ($696,623 + $165,229 - $1,020).

On March 25, 1983, Zeus repaid the $51,000 loan outstanding

from IRA. On October 21, 1983, Zeus transferred $774,000 to IRA

in exchange for a $774,000 receivable from Holding Co. During

1983, Zeus transferred $28,000 to IRA in exchange for $28,000 of

receivables from Holding Co.26 Thus, during 1983, Zeus

transferred a total of $853,000 in cash to IRA in repayment of a

loan and in exchange for Holding Co. receivables.

IRA's 1983 consolidated return reported that Zeus' assets at

the end of the year included cash of $7,832, loans receivable of

$866,000, partnership interests with a negative value of $20,875,

and other assets (capitalized organizational expenses) of $32.

From 1979 through 1983, Zeus apparently invested a net of

$163,685 in partnerships.27

26
On December 5, 1983, Zeus transferred $13,000 to IRA in
exchange for a $13,000 receivable from Holding Co. IRA's general
ledger shows that in 1983 Holding Co.'s subsidiary Zion acquired
from IRA a $15,000 receivable due from Holding Co. for $15,000.
The 1984 general ledger shows that Zeus' loans receivable of
$866,000 included $802,000 owed by Holding Co. and $64,000 owed
by HELO. The record does not disclose how Zeus acquired the
remaining receivable of $15,000 from Holding Co.
27
Based on IRA's consolidated returns, Zeus contributed to
unidentified partnerships $100,000 in 1979 and $127,372 in 1980
and received a return of capital of $63,696 in 1981 and $1 in
1982 (probably due to rounding of numbers) computed as follows:

(continued...)
 - 149 -

From 1979 through 1983, Zeus received a total of $1,111,470

from the following sources:

(...continued)
1979 Initial contribution $100,000
Plus 1980 nontaxable income 6,828
Total adjustments and contributions 106,828

Plus 1980 contributions
value end 1980 234,200
less prior adjustments and contributions (106,828)
1980 contributions 127,372 127,372
Value end 1980 234,200

Value end 1980 234,200
plus 1980 taxable income 2,382
total adjustments and contributions 236,582

Less return of capital
value end 1981 172,896
less prior adjustments and contributions (236,582)
1981 return of capital (63,686) (63,686)
Value end 1981 172,896

Value end 1981 172,896
Less 1982 taxable loss (150,907)
Less 1982 nontaxable loss (27,061)
total adjustment and contributions (5,072)

Less return of capital
value end 1982 (5,073)
less prior adjustments and contributions 5,072
1982 return of capital (1) (1)
Value end 1982 (5,073)

Value end 1982 (5,073)
Less 1983 taxable loss (15,049)
Less 1983 nontaxable loss (753)
Value end 1983 (20,875)
 - 150 -

Zeus distributed the $1,111,470 of funds as follows:

c. Payments From Schnitzer-PMS, Essex, and Schaffel 1979
Through 1983

From 1979 through 1983, Essex paid IRA a total of $164,587,

PMS paid IRA a total of $1,941,505 in principal and interest on

the repurchase of the PMS stock, and Schaffel paid $1,184,876 to

IRA representing 50 percent of the broker's fees he received from

Prudential transactions.28

d. Funds Accumulated in IRA at Close of 1983

At the close of 1983, IRA had accumulated $4,771,445 from

payments made by the Five related to the Prudential transactions

as shown in the following diagram:

28
Schaffel also paid $312,750 to IRA in 1983 for fees related
to Traveler's transactions.
 - 151 -

IRA's balance sheet showed the following assets,

liabilities, and stockholder equity at the close of 1983:

Assets
Cash $110,281
Notes/accounts receivable 2,070,128
Loans receivable 1,592,983
Short-term securities 3,776,000
Loans to stockholders 292,260
Investment/partnerships 1,640,284
Investment/subsidiaries 83,000
Marketable securities 564,827
Non-marketable securities 192,700
Pooled funds 38,250
Buildings & other depreciable assets 11,286,020
Less accumulated depreciation (7,636,902)
Deposits 2,365
Total 14,012,196
Liabilities
Short-term mtg., notes, bonds 1,341,617
Long-term mtg., notes, bonds 11,060,633
Deferred gain 1,969,973
Total 14,372,223
Net assets (360,027)
Capital stock 100
Retained earnings (360,127)
 - 152 -

3. 1984 Distributions to Carlco, TMT, and BWK, Inc.

In 1984, IRA began distributing cash and other property to

Carlco, TMT, and BWK, Inc. The distributions were made in a

ratio of 45/45/10 to Carlco, TMT, and BWK, Inc.

a. 1984 Distributions of Cash From IRA to Carlco, TMT, and BWK,
Inc.

During 1984, IRA transferred $4,156,739 to Carlco, TMT, and

BWK, Inc. The $1,870,532 to each of Carlco and TMT and $415,675

to BWK, Inc., was distributed on the dates and in the amounts

indicated:

Date Carlco TMT BWK, Inc. Total

01/04/84 $540,000 $540,000 $120,000 $1,200,000
01/10/84 90,000 90,000 20,000 200,000
01/13/84 90,000 90,000 20,000 200,000
01/17/84 112,500 112,500 25,000 250,000
01/24/84 225,000 225,000 50,000 500,000
02/01/84 90,000 90,000 20,000 200,000
02/06/84 112,500 112,500 25,000 250,000
02/07/84 90,000 90,000 20,000 200,000
02/10/84 90,000 90,000 20,000 200,000
02/15/84 45,000 45,000 10,000 100,000
02/22/84 36,900 36,900 8,200 82,000
02/29/84 45,000 45,000 10,000 100,000
03/20/84 142,086 142,086 31,575 315,747
04/12/84 40,500 40,500 9,000 90,000
07/17/84 52,200 52,200 11,600 116,000
07/31/84 11,700 11,700 2,600 26,000
10/10/84 16,456 16,456 3,658 36,570
10/16/84 40,690 40,690 9,042 90,422
Total 1,870,532 1,870,532 415,675 4,156,739
 - 153 -

b. 1984 Distribution of Essex Partnership Interest to Carlco,
TMT, and BWK, Inc.

For the taxable years 1982 through 1983, Essex made the

following distributions to IRA that were reported by IRA in the

year indicated:

Payment Date Year Reported Amount
09/28/82 1982 $47,025
12/30/82 1983 39,187
06/03/83 1983 26,125
07/08/83 1983 26,125
10/03/83 1983 26,125
Total 164,587

IRA also recorded its distributable share of income from

Essex as $89,214 for 1982 and $120,656 for 1983. IRA recorded

the value of its interest in Essex as follows:

1982 beginning value --
Plus 1982 share of income $89,214
Less 11/30/82 payment (47,025)
Investment end of 1982 42,189

1983 beginning value 42,189
Plus 1983 share of income 120,656
Less distributions
01/06/83 dividend (39,187)
06/07/83 distribution (26,125)
07/11/83 distribution (26,125)
10/15/83 distribution (26,125)
Investment end of 1983 45,283

During 1984, IRA received the following distributions from

Essex:

01/26/84 Distrib from Essex $44,413
05/08/84 Essex 26,125
07/06/84 Essex distrib. 26,125
10/04/84 Essex 36,575
 - 154 -

IRA recorded the receipt of the $44,413 payment received

from Essex in January as payables of $19,986 due to each of

Carlco and TMT and $4,441 due to BWK, Inc.29 On January 30,

1984, IRA issued checks in the appropriate amounts to each of the

corporations and recorded the payments as payment of the payables

owed to Carlco, TMT, and BWK, Inc. The remaining $88,825 from

Essex was also treated as distributed directly to Carlco, TMT,

and BWK, Inc., by reducing the additions to capital attributable

to IRA's contributions of cash made to the corporations during

the year.

In December 1984, IRA distributed its Essex partnership

interest in the ratio of 45 percent each to Carlco and TMT and 10

percent to BWK, Inc. IRA recorded the distribution of the Essex

partnership interest on its books as follows:

1984 beginning value $45,283
Less distribution of
investment as paid in capital (45,283)
Less distributions from Essex
05/08/84 (26,125)
07/06/84 (26,125)
10/04/84 (36,575)
Plus "distb exxex dist as pd in" 88,825
Investment end of year -0-

Carlco, TMT, and BWK, Inc. recorded the receipt of the Essex

partnership interest as follows (balance differences are due to

rounding):

29
The difference between total of $44,412 and $44,413 is due
to rounding of numbers.
 - 155 -

Item Carlco TMT BWK Total

Investment in Essex
Beginning year -0- -0- -0- -0-
Essex interest from IRA $20,377 $20,377 $4,528 $45,282
K-1 from Essex 60,520 60,520 13,449 134,489
Distribution from Essex (19,986) (19,986) (4,441) (44,413)
1984 Essex distribution
from IRA (39,971) (39,971) (8,882) (88,824)
End year investment 20,940 20,940 4,653 46,533

Paid in Capital
Essex interest from IRA 20,377 20,377 4,653 45,282
Essex distribution
received from IRA (39,971) (39,971) (8,882) (88,824)

c. Transfer of Sherwood Partnership Interest From IRA to
Carlco, TMT, and BWK, Inc.

In 1982, IRA invested $175,000 in a partnership called

Sherwood Associates (Sherwood). IRA held a 50-percent interest

in Sherwood and reported an $89,577 loss from Sherwood for 1982.

IRA's Sherwood partnership interest was reflected on IRA's books

at the end of 1982 as follows:

Opening balance --
Record transactions thru Nov. 1982 $100
Transfer via Administration Co. client 124,900
Reclassify loan to investment 50,000
Adjustment for 1982 loss (89,577)
Account total 85,423

In 1983, IRA invested an additional $150,000 in Sherwood and

IRA was allocated a $287,165 loss for the year. IRA's interest

in the Sherwood partnership was reflected on the books at the end

of 1983 as follows:
 - 156 -

Opening balance $85,423
Contribution to partnership 150,000
1983 loss (287,165)
Account total (51,742)

On December 31, 1984, IRA transferred its 50-percent

interest in the Sherwood partnership, 45 percent each to Carlco

and TMT and 10 percent to BWK, Inc. As a result, Carlco and TMT

each received a 22.5-percent interest in the Sherwood partnership

and BWK, Inc., received a 5-percent interest. IRA reported a

gain of $51,742 (the excess of the $376,742 of total losses

claimed over IRA's total investment of $325,000) on the transfer

of its interest in Sherwood and recorded the transfer on its

books as follows:

Investment in Sherwood
Opening balance ($51,742)
Gain on distribution of Sherwood 51,742
Account total 0

Investment in Carlco
Rec. gain on dist of Sherw 1

Investment in TMT
Rec. gain on dist of Sherw 1
Investment in BWK, Inc.
Rec. gain on dist of Sherw 1

Adjusting Journal Entry 21
Invest in Sherwood 51,742
Invest in Carlco 1
Invest in BWK 1
Invest in TMT 1
Gain on sale of Pship 51,745

Carlco, TMT, and BWK, Inc., recorded the contribution of the

Sherwood partnership as follows:
 - 157 -
Carlco TMT BWK, Inc.
Investment in Sherwood
Opening balance – – –
Sherwood Associates $41,400 $41,400 $9,200
Rec. int. Sherwood from IRA 1 1 1
Rec. K-1 activity (119,116) (119,116) (26,470)
Paid-in Capital (77,715) (77,715) (17,269)

Rec. int. Sherwood from IRA 1 1 1

d. 1984 Distributions to Carlco, TMT, and BWK, Inc. as
Reflected on the Books of the Corporations

The transfers of cash to Carlco, TMT, and BWK, Inc., were

recorded on the books of the corporations as, respectively,

contributions of capital. The distribution of the Essex

partnership interest was recorded as paid-in capital of $20,377

each to Carlco and TMT and $4,528 to BWK, Inc. The distribution

of the Sherwood partnership interest was recorded as paid-in

capital of $1 each to Carlco, TMT, and BWK, Inc. Additionally, a

receivable of $148 for the preferred shares of each of Carlco,

TMT, and BWK, Inc. was treated as paid-in capital of each

corporation. Thus, amounts recorded as additions to capital

during 1984 and total paid-in capital at the close of 1984 for

each of the corporations were as follows (balance differences are

due to rounding):

Item Carlco TMT BWK, Inc.

Cash $1,870,535 $1,870,535 $415,674
Essex distribution (39,971) (39,971) (8,882)
Essex partnership 20,377 20,377 4,528
Sherwood partnership 1 1 1
Receivable 148 148 148
Consent dividend 105,202
Total 1984 additions 1,851,091 1,956,294 411,470
Paid in capital
Beginning year 7,398 7,398 7,398
End year 1,858,489 1,963,691 418,868
 - 158 -

4. Flow of Payments by the Five 1985 Through 1989
After IRA transferred money from the Five to Carlco, TMT,

and BWK in 1984, the structure in which payments were received

from the Five changed. The payments from Essex and Hyatt

(through KWJ Partnership) were no longer reported as IRA's

income. Carlco, TMT, and BWK became partners of the Essex

partnership and formed the KWJ Co. partnership. Hyatt payments

were reported as income of KWJ Co. partnership. Accordingly, the

payments from the Essex and KWJ Co. partnerships were reported on

the respective returns of Carlco, TMT, and BWK at that time, and

Carlco, TMT, and BWK were no longer members of the consolidated

group of IRA for tax purposes.

a. Zeus 1984 Through 1988

IRA's consolidated returns for 1984 through 1988 reported

the following income, net assets, and stockholder equity with

respect to Zeus:
 - 159 -
1984 1985 1986 1987 1988

Income
Interest $4,191 $13,639 $6,586 $684 $3,090
Commission 103,500 128,763 -- -- --
Partnership (203,947) (198,310) -- (31,204) (166,802)
Total Income (96,256) (55,908) 6,586 (30,520) (163,712)
Deductions (217) (727) (4,600) (105) (275)
Net income (96,473) (56,635) 1,986 (30,625) (163,987)
NOL –- (96,473) (153,108) (151,122) (181,747)
Taxable (96,473) (153,108) (151,122) (181,747) (345,734)

Assets
Cash 219 855 3,971 3,866 3,591
Loan rec. 871,028 871,028 871,028 871,028 871,028
Partnerships (224,822) (424,040) (424,040) (454,560) (618,272)
Pooled funds 110,091 251,130 -- -- --
Non-mar. sec –- -- 250,000 250,000 250,000
Total 756,516 698,973 700,959 670,334 506,347
Liabilities -– –- –- –- –-
Net assets 756,516 698,973 700,959 670,334 506,347

Capital stock 100 100 100 100 100
Capital 49,900 49,900 49,900 49,900 49,900
surplus 706,516 648,973 650,959 620,334 456,347
Retained earn.

The Frey corporation paid Zeus $103,500 in 1984 and $128,763

in 1985 (totaling $232,263). During 1984, Zeus transferred

$5,028 to Holding Co. The transfer increased the Holding Co.

receivable from $802,000 owed by Holding Co. at the beginning of

the year to $807,028 owed at the end of the year. During 1986,

Zeus purchased 25 shares of preferred stock in another Kanter

entity called Windy City, Inc. for $250,000. During 1988, Zeus

eliminated the HELO receivable in exchange for the following

receivables owed to HELO by the parties indicated:
 - 160 -

APS Insurance $4,570
Beach Trust 17,651
R Trust 10,000
Softy Trusts 10,600
Grasshopper Trust 16,250
Pamela Osowski 4,929
Total 64,000

Zeus never accrued any interest or received any payments on

any of those receivables or the receivables from Holding Co. and

HELO.

b. Distributions of Schnitzer-PMS and Essex Payments Made
During 1985 Through 1989

During 1985, IRA received funds from Schnitzer-PMS and Essex

and made distributions to Carlco, TMT, and BWK, Inc. as follows:

1985 Receipts Distributions

01/15 Qrtly payment $90,423
01/21 Carlco $40,500
TMT 40,500
BWK, Inc. 9,000
Essex-Blng to TMT, etc. 41,800
01/30 Pymt on amts owed re Essex 18,450
18,450
4,100
04/08 Schnitzer Corp./qrtly inst
/int balloon 90,423
04/16 Carlco 40,500
TMT 40,500
BWK, Inc. 9,000
04/18 Essex 1st quarter dist. 13,063
04/25 Carlco 5,850
TMT 5,850
BWK, Inc. 1,300
07/03 Schnitzer Corp.
qrt. pmt.($10,000 int BA) 90,423
07/08 Essex 2d quarter dist. 36,575
07/11 Carlco 16,200
TMT 16,200
BWK, Inc. 3,600
10/03 Essex 3d quarter 28,738
10/04 Schnitzer Corp. 3d quarter 90,423
 - 161 -

10/15 Carlco 81,000
TMT 81,000
BWK, Inc. 18,000

IRA recorded the 1985 payments to Carlco ($184,050), TMT

($184,050), and BWK, Inc. ($40,900) as follows (balance

differences are due to rounding):

Item Carlco TMT BWK, Inc.

Note to
Beginning -- -- --
07/11 additional $16,200 $16,200 $3,600
04/18 Essex (5,878) (5,878) (1,306)
07/08 Essex (16,459) (16,459) (3,658)
10/03 Essex (12,931) (12,931) (2,874)
12/31 Rec to proper account (16,200) (16,200) (3,600)
12/31 To combine same acct (360) (360) (80)
Ending (35,629) (35,629) (7,917)

Notes payable
Beginning -- -- --
01/13 Pymt on amts owed re Essex 18,450 18,450 4,100
01/21 FM Essex--blngs to TMT etc (18,810) (18,810) (4,180)
12/31 To combine same account 360 360 80
Ending -- -- --

Investment in stock
Beginning 1,856,942 1,962,144 417,321
01/21 additional capital 40,500 40,500 9,000
04/16 additional capital 40,500 40,500 9,000
04/25 additional capital 5,850 5,850 1,300
10/14 additional capital 81,000 81,000 18,000
12/31 R/C to proper account 16,200 16,200 3,600
To record consent dividend 97,206
Ending 2,040,992 2,243,400 458,221

1986

The record does not contain detailed general ledgers for IRA

after 1985. The record indicates, however, that IRA recorded the

1986 payments from Schnitzer-PMS and Essex and distributions to

Carlco, TMT, and BWK, Inc. as follows:
 - 162 -
Item Carlco TMT BWK, Inc.
Note to
Beginning ($35,629) ($35,629) ($7,917)
Pd 2/86 35,629 35,629 7,917
Ending -0- -0- -0-

Investment in stock
Beginning 2,040,992 2,243,400 458,221
Ending 2,203,362 2,488,403 494,303
Contri. consent dividend 82,633
Cash additions 162,370 162,370 36,082

1987

IRA recorded the 1987 payments from Schnitzer-PMS and Essex

and distributions to Carlco, TMT, and BWK, Inc. as follows:

Item Carlco TMT BWK, Inc.
Note to
Beginning -- -- --
08/06/87 Essex 2d quarter ($29,626) ($29,626) ($6,584)
10/08/87 Distr. Essex 29,626 29,626 6,584
12/10/87 Essex 3d quarter (8,229) (8,229) (1,829)
12/15/88 Distr. Essex 8,229 8,229 1,829
Ending -- -- --

Investment in stock
Beginning 2,203,362 2,488,403 494,303
Additions
01/14/87 40,690 40,690 9,042
05/07/87 40,690 40,690 9,042
09/10/87 40,690 40,690 9,042
10/19/87 40,690 40,690 9,043
12/11/87 29,553 29,553
Total cash contrib. 192,313 192,313 36,169
12/31/87 consent div. 31,960
Ending 2,395,676 2,712,677 530,473

1988

IRA recorded the 1988 payments from Schnitzer-PMS and Essex

and distributions to Carlco, TMT, and BWK, Inc. as follows:

Item Carlco TMT BWK, Inc.
Investment in stock
Beginning $2,395,676 $2,712,677 $530,473
Additions
02/03/88 40,690 40,690 9,042
05/12/88 40,690 40,690 9,042
08/05/88 40,690 40,690 9,042
12/13/88 40,690 40,690 9,043
Total 162,761 162,761 36,169
2/31/88 consent div. 65,093
Ending 2,558,437 2,940,531 566,642
 - 163 -

1989

IRA recorded the 1989 payments from Schnitzer-PMS and Essex

and distributions to Carlco, TMT, and BWK, Inc. as follows:

Item Carlco TMT BWK, Inc.
Note receivable from
Beginning -- -- --
09/14/89 loan $55,000 $35,000 --
09/18/89 void check (55,000) (35,000) --
09/18/89 loan 117,000 44,000 --
12/04/89 loan 5,355 10,274 --
Ending 122,355 54,274 --

Notes payable to
Beginning -- -- --
01/11/89 Essex 4th quarter dist. (20,573) (20,573) ($4,572)
01/11/89 Dist. 20,573 20,573 4,572
01/18/89 Dist. 20,573 20,573 --
01/18/89 void check (20,573) (20,573) --
07/26/89 Essex 1&2 quarter dist. (15,048) (15,048) (3,344)
08/02/89 Dist. 15,048 14,048 3,344
08/23/89 Essex dist. (8,229) (8,229) (1,829)
08/28/89 Dist. 8,229 8,229 1,829
Ending -- -- --

Investment in stock
Beginning 2,558,437 2,940,531 566,642
Additions
03/20/89 378,190 378,190 84,042
Rcls amended consent dividend
from TMT 1986-1988 (179,686)
Ending 2,936,627 3,139,035 650,684

c. Loans From IRA to KWJ Partnership Through 1989

In addition to payments made to Carlco, TMT, and BWK, Inc.,

that were treated as additions to capital, IRA made distributions

recorded as loans to KWJ partnership as follows:

Receivable 1985 1986 1987 1988 1989
Beginning year $30,000 $75,500 $113,500 $161,500 $181,500
Loans during year 45,500 38,000 48,000 20,000 68,370
End year 75,500 113,500 161,500 181,500 249,870

d. Balance Sheets of Carlco, TMT, and BWK, Inc. 1983 Through
1989

The balance sheets for Carlco, TMT, and BWK, Inc. for the

years 1983 through 1989 were as follows:
 - 164 -
Carlco 1983 1984 1985 1986 1987 1988 1989

Assets $7,500 $1,967,188 $2,327,066 $2,699,998 $3,078,545 $3,728,530 $4,404,569
Liabilities 4,000 4,000 122,355
Net assets 7,500 1,967,188 2,323,066 2,699,998 3,074,545 3,728,530 4,282,214

Cap. stock
Common 100 100 100 100 100 100 100
Preferred 2 3 3 3 3 3 3
Capital surplus 7,398 1,858,489 2,042,539 2,168,127 2,397,222 2,559,983 2,938,173
Retained earnings 108,596 280,424 531,768 677,220 1,168,444 1,343,938
Total equity 7,500 1,967,188 2,323,066 2,699,998 3,074,545 3,728,530 4,282,214

Increase in 1,851,091 184,050 125,588 229,095 162,761 378,190
surplus

TMT 1983 1984 1985 1986 1987 1988 1989

Assets $7,500 $2,015,911 $2,293,151 $2,518,717 $2,735,965 $3,215,925 $3,880,997
Liabilities 4,000 54,274
Net assets 7,500 2,015,911 2,289,151 2,518,717 2,735,965 3,215,925 3,826,723

Cap. stock
Common 100 100 100 100 100 100 100
Preferred 2 3 3 3 3 3 3
Capital surplus 7,398 1,963,692 2,244,947 2,489,950 2,714,224 2,942,077 3,140,582
Retained earnings 52,116 44,101 28,664 21,638 273,745 686,038
Total equity 7,500 2,015,911 2,289,151 2,518,717 2,735,965 3,215,925 3,826,723

Increase in
surplus 1,956,294 281,255 245,003 224,274 227,853 198,505

Book income 157,318
Consent dividend 105,202 97,206 82,633 31,960 65,093 -0-
Retained earnings 52,116

Surplus increase 1,956,294 281,255 245,003 224,274 227,853 378,190
Consent dividend 105,202 97,206 82,633 31,960 65,093 *179,786
Difference 1,851,092 184,049 162,370 192,314 162,760 198,404

*Reverse 86, 87 & 88 consent dividend paid to IRA.
 - 165 -
BWK, Inc. 1983 1984 1985 1986 1987 1988 1989

Assets $7,500 418,558 406,909 388,362 395,808 451,711 515,772
Liabilities 7,534 1,000 286 8,000 -0- 2,253
Net assets 7,500 411,024 405,909 388,076 387,808 451,711 513,519

Cap. stock
Common 100 100 100 100 100 100 100
Preferred 2 3 3 3 3 3 3
Capital surplus 7,398 418,868 459,768 495,869 532,038 568,207 652,250
Retained earnings (7,947) (53,962) (107,896) (144,333) (116,599) (138,834)
Total equity 7,500 411,024 405,909 388,076 387,808 451,711 513,519

Increase in
surplus 411,470 40,900 36,101 36,169 36,169 84,043
 - 166 -

B. Flow of the Funds Paid By the Five Through IRA and Its
Subsidiaries to Kanter, Ballard, and Lisle
1. Overview
The payments from the Prudential transactions were

distributed by various means either directly to Ballard, Lisle,

and Kanter or indirectly through their family members or trusts

and other entities established for the benefit of their families.

Some distributions were recorded as receivables owed by the

person or entity receiving the distribution; others were recorded

as consulting fees or director's fees. Distributions from KWJ

Corp. and later KWJ partnership to Ballard's and Lisle's children

were treated as consulting fees.

In 1983, IRA began distributing the funds accumulated from

the Prudential transactions to Carlco, TMT, and BWK, Inc. Lisle

was given control over the funds in Carlco, Ballard was given

control over the funds in TMT, and Kanter was given control over

the funds in BWK, Inc. Lisle, Ballard, and Kanter treated the

funds as their own and used the funds for their personal benefit.

2. Payments from IRA, KWJ Corp., and KWJ Co. Partnership

a. 1982: IRA Payments to Ballard and Lisle

In 1982, Ballard received $12,500 from IRA as a "director's

fee". The check was dated in 1981 but cashed in 1982. On March

2, 1982, IRA paid Lisle $1,157.84.
 - 167 -

b. Consulting Fees Paid to Ballard's and Lisle's Children

Melinda Ballard and Karen Ballard Hart were Ballard's

daughters. Amy Albrecht was Lisle's daughter, and Thomas Lisle

was Lisle's son. In 1982, KWJ Corp. (and later the KWJ

partnership) began paying Thomas Lisle, Amy Albrecht, and Melinda

Ballard $1,000 each per month.30 In 1984, the KWJ partnership

began paying Karen Hart $1,000 each month. The payments

continued until at least 1989. From 1982, KWJ Corp. and the KWJ

partnership paid the Lisle and Ballard children the following

amounts as consulting fees:31

Lisle Children Ballard Children
Year Thomas Lisle Amy Albrecht Melinda Ballard Karen Hart
1982 $7,000 $7,000 $7,000 --
1983 12,000 12,000 12,000 --
1984 12,000 12,000 12,000 $2,000
1985 12,000 11,000 12,000 12,000
1986 12,000 13,000 12,000 12,000
1987 12,000 12,000 12,000 12,000
1988 12,000 12,000 12,000 12,000

30
Thomas Lisle and Amy Albrecht admitted that they received
consulting fees from 1983 to 1989. Melinda Ballard admitted that
she received the consulting fees from 1983 to 1988. Karen Hart
admitted that she received the consulting fees from 1984 to 1989.
No one except the Lisle and Ballard children received consulting
fees from 1983 through 1989. We conclude that the payments made
in 1982 were also made to Thomas Lisle, Amy Albrecht, and Melinda
Ballard.
31
Approximately $4,000 per month was paid to the Ballard and
Lisle children. IRA made distributions to KWJ Corp. and KWJ
partnership that were also approximately $4,000 a month. The
money distributed to KWJ Corp. and KWJ partnership was never
repaid during the years in question, and no interest was ever
paid on the amounts outstanding.
 - 168 -

During 1989, KWJ partnership paid the Lisle and the Ballard

children $36,000. Of the $36,000 paid, Lisle's children received

at least $18,000 and Ballard's children received at least

$12,000.32

None of the Ballard or the Lisle children performed any

services for KWJ Corp. or KWJ partnership. The Hyatt payments

and interest were the only sources of income KWJ Corp. or KWJ

partnership ever received.

In February 1990, after the Internal Revenue Service began

examining Ballard's, Kanter's, and Lisle's returns for the years

at issue, Kanter sent letters to the children terminating KWJ

Co’s. "consulting arrangement" with them. In the letters Kanter

stated that the children had done nothing for a number of years.

c. KWJ Partnership 1989 Payments to Lisle and Ballard

As noted earlier, Carlco, TMT, and BWK, Inc., organized the

KWJ Partnership. The Hyatt payments were issued by Hyatt to

Weaver who forwarded the payments to the KWJ Partnership, out of

which Weaver was paid his 30 percent and the balance was

distributed to Carlco, TMT, and BWK, Inc.

32
The record is unclear whether all four each received $9,000,
or whether Thomas Lisle, Amy Albrecht, and Karen Hart each
received $12,000. Melinda Ballard testified that she resigned
from KWJ Co. in 1988. If that was the case, then of the $36,000
paid by KWJ Co. in 1989, Thomas Lisle, Amy Albrecht, and Karen
Hart each received $12,000. If Melinda Ballard did not resign,
then each of the four children received $9,000 during 1989.
Thomas Lisle and Amy Albrecht together received at least $18,000
during 1989, and Ballard's children received at least $12,000.
 - 169 -

On August 2, 1989, IRA issued checks in the amount of

$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 Company" on August 8, 1989. Also on August 8,

1989, ledger entries reflected that the check to Lisle for

$22,618.80 was "void". Another ledger entry, on August 15, 1989,

reflected that the check to Ballard for $22,618.80 was "void".

Despite the fact that IRA's ledger entries stated that these

checks were void, Lisle's 1989 return reflected that he received

this money and that the check was not "voided." Lisle reported

the $22,619 on his return as income from the "KJW [sic] Company."

3. Disposition of Funds out of Carlco, TMT, and BWK to Kanter

a. Creation of Carlco, TMT, and BWK, Inc.

The certificates of incorporation of Carlco, TMT, and BWK,

Inc., authorized each corporation to issue 1,000 shares of 10-

cent par value common stock. Certificates of amendment for each

corporation were filed in December 1983. The amended

certificates authorized the corporations to issue 11,000 shares

of stock comprised of 10,000 shares of 1-cent par value preferred

stock and 1,000 shares of 10-cent par value common stock. The

amended certificates granted each corporation's board of

directors authority to fix the dividend rights, dividend rate,

conversion rights, voting rights, the rights and terms of

redemption (including sinking fund provisions), the redemption
 - 170 -

price or prices, and the liquidations preferences of the

preferred shares. The record does not contain copies of any

resolutions by the board of directors of any of the three

corporations setting preferences or limitations on the preferred

stock.

Kanter was a beneficiary of a trust called the Morkan

Trust.33 On October 17, 1983, Kanter exercised a power of

appointment over the Morkan Trust to form the Christie and Orient

Trusts. Sharon Meyers was named as trustee of the Christie and

Orient Trusts. Members of Lisle's family were named as

beneficiaries of the Christie Trust, and members of Ballard's

family were named as beneficiaries of the Orient Trust.

In December 1983, IRA acquired 1,000 shares (100 percent) of

the common stock of each of Carlco, Inc. (Carlco), TMT, Inc.

(TMT), and BWK, Inc. (BWK). IRA paid $6,000 to each of the

corporations for the shares of stock. Also in December 1983,

Carlco, TMT, and BWK each issued 150 shares of preferred stock

for $1,500. 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); BWK preferred shares

were issued to the BK Children's Trust, the beneficiaries of

which were members of Kanter's family.

33
The Morkan Trust is named after Kanter's father, Morris
Kanter.
 - 171 -

In January 1984, Carlco, TMT, and BWK each issued 150

additional shares of preferred stock for $150. Carlco issued the

additional preferred shares to the Christie Trust, TMT issued the

additional preferred shares to the Orient Trust, and BWK issued

the additional preferred shares to the BK Children's Trust. As a

result of those trusts' ownership of these preferred shares,

Carlco, TMT, and BWK, Inc., no longer qualified as members of

IRA's consolidated group of corporations and were not included in

the consolidated tax returns IRA filed.

b. Control and Management of Carlco, TMT, and BWK, Inc.

Kanter directed Freeman (IRA's president) to distribute

funds received by IRA related to Prudential transactions in the

ratio of 45 percent to Carlco, 45 percent to TMT, and 10 percent

to BWK. From 1984 through 1989, IRA generally transferred funds

and other assets to Carlco, TMT, and BWK, Inc., in the respective

45-45-10 allocation ratio Kanter had directed.

Lisle managed and controlled Carlco's investments. Lisle

and members of his family, including his wife Donna Lisle and his

son Thomas Lisle, had signatory authority over Carlco's accounts.

In 1982 Kanter, his brother Carl Kanter, and Meyers were the

officers and/or directors of Carlco. In 1983, Meyers and Freeman

were the directors, president, and treasurer, and Gallenberger

was secretary. From 1984 through 1989, there were no directors

listed; Lisle, his brother Henry Lisle, his son Thomas Lisle, and
 - 172 -

his wife Donna Lisle served as president or vice president, D.

Dubanevich was secretary; and, except for 1985,34 Meyers or

Gallenberger was treasurer.

Ballard managed and controlled TMT's investments. Ballard

and members of his family, including his wife Mary Ballard, had

signatory authority over TMT's accounts. In 1982, Kanter, his

son Joshua, and Meyers were the directors of TMT, Kanter was

president, his son Joshua was treasurer, and Meyers was vice

president and secretary. Between 1983 and 1989, Freeman, Meyers,

and/or Gallenberger were the directors and officers.

Kanter managed and controlled BWK, Inc.'s investments. In

1982, Kanter, his son Joshua, and Meyers were the directors and

officers of BWK, Inc. From 1983 through 1989, Weisgal was the

sole director and president, Kanter, Meyers, and/or Gallenberger

were the remaining officers.35 In 1990, Kanter was the sole

director and president, and Gallenberger was secretary.

After Carlco, TMT, and BWK, Inc., were organized, the

payments by the Five were distributed to Carlco, TMT, and BWK,

Inc.

34
No treasurer was listed for 1985.
35
No treasurer was listed from 1985 through 1990, and no vice
president was listed from 1983 through 1987 and in 1990.
 - 173 -

c. Ballard: Disposition of Funds out of TMT

During the years 1982 through 1989, the following

individuals were listed as the "officers" and "directors" of TMT:

Title 1982 1983 1984
Directors Kanter Freeman Freeman
Joshua Kanter Meyers Meyers
Meyers
President Kanter Meyers Meyers
Vice president Meyers
Secretary Meyers Gallenberger Gallenberger
Treasurer Joshua Kanter Meyers Meyers
Assistants Joshua Kanter

Title 1985 1986 1987
Directors Meyers Gallenberger Gallenberger
President Meyers Gallenberger Gallenberger
Vice president
Secretary Gallenberger Gallenberger Gallenberger
Treasurer Meyers Gallenberger Gallenberger
Assistants

Title 1988 1989
Directors Gallenberger Gallenberger
President Gallenberger Gallenberger
Vice president
Secretary Gallenberger Gallenberger
Treasurer
Assistants

The records for TMT were maintained at Ballard's home.

TMT's business address was the same as Ballard's residence in

Seabright, New Jersey. Mail for TMT was received at Ballard's

home. Correspondence from TMT was sent from Ballard's home

address.

i. TMT Accounts

During 1984, IRA transferred over $1 million to TMT. The

money generally was deposited into TMT's account with the
 - 174 -

Administration Co., and certificates of deposit (CD's) were

purchased through Administration Co.'s account at the American

National Bank in Chicago.

At the end of 1984, the money designated for TMT in CD's at

the American National Bank in Chicago, purchased through the

Administration Co. account, totaled $1,604,000. By the end of

the year 1985, no money designated for TMT was in CD's at the

American National Bank in Chicago. The money that had been in

CD's at the American National Bank in Chicago was transferred

into CD's at the Wells Fargo Bank in San Francisco. By the end

of the year 1985, the amount of money in CD's at the Wells Fargo

Bank San Francisco totaled $1,874,295.

During the years 1984 through 1989, moneys other than CD's

for TMT were deposited in an account maintained at the Wells

Fargo Bank, in San Francisco, account No. 170-752. The mailing

address of this account was 65 Island View Townhouses, Seabright,

New Jersey, which was the Ballard residence address. Ballard

opened this account in the name of "TMT", and he and his wife had

signatory authority over it. The money in this account at the

end of the years 1984 through 1989 was as follows:

Year Wells Fargo
1984 –
1985 $8,768
1986 19,438
1987 157,489
1988 192,915
1989 141,968
 - 175 -

By the end of the year 1986, the amount of money in CD's at

the Wells Fargo Bank decreased to zero. Of the money that had

been in CD's, $1,205,900 had been transferred to a Goldman Sachs

brokerage account. The money in the Goldman Sachs brokerage

account at the end of the years 1987 through 1989 was as follows:

Year Goldman Sachs
1987 $53,803
1988 75,460
1989 155,300

During the years 1986 through 1989, moneys for TMT were

deposited in an account maintained at the Citizen Bank. The

balance in this account at the end of the years 1986 through 1989

was as follows:

Year Citizen Bank
1986 $25,248
1987 26,600
1988 1,929
1989 2,023

TMT also had a money market account (Kemper Money Market

account). At the end of the year 1989, there was a balance of

$349,182 in the Kemper Money Market account.

ii. "Loans" From TMT

In 1984 receivables owed by Ballard's Seabright Trust and

Seabright Corp. respectively in the amounts of $12,255 and

$31,440 were transferred from Administration Co. to TMT. From

1984 through 1989, the Seabright Trust and Seabright Corp.

received additional "loans" totaling $132,980 from TMT. The

balances on these loans at the end of each year were as follows:
 - 176 -

Seabright Seabright
Year Trust Increase Corp. Increase
Trans. from
Special E $12,255 -- $31,440 –-
1984 53,055 $40,800 31,440 –-
1985 79,155 26,100 31,520 $80
1986 100,155 21,000 36,520 5,000
1987 100,155 -- 41,520 5,000
1988 135,155 35,000 41,520 --
1989 135,155 -- 41,520 –-
Total 122,900 10,080

There were no notes in connection with the "loans" to the

Seabright Trust or the Seabright Corp. There is no evidence that

either the Seabright Trust or Seabright Corporation paid interest

on the "loans" from TMT. The loans were never repaid.

From 1984 through 1989, Claude Ballard and Mary Ballard

received a total of $303,943 from TMT as "loans". The balances

due on these loans at the end of each year were as follows:

Year Claude Ballard Mary Ballard
1984 $10,599 –
1985 10,599 $160,000
1986 16,599 160,000
1987 36,943 160,000
1988 136,943 160,000
1989 146,943 160,000

With respect to the $160,000 "loan" to Mary Ballard, during

1985, a document dated December 26, 1986, purported to provide

for the repayment of this "loan" with Macy's stock held privately

by Ballard. The records of TMT do not indicate that the $160,000

"loan" was repaid. The records of TMT do not indicate that the

Macy's stock was given to TMT in accordance with the December 26,

1986, document.
 - 177 -

In 1986, $100,000 of TMT funds were used to purchase land

described in the TMT general Ledger as "St. Francis Arkansas -

Land." The cost of this land was $100,000. In 1987, this

property was transferred to Ballard. Book entries were made to

reflect this transaction. "Loans" to Ballard were increased by

$100,000. The land was no longer reflected as a TMT asset. The

adjusting journal entry that went with the transfer to Ballard

described the property as the "Fairfield Planting Company".

This "loan" has never been repaid. In 1987, TMT paid an

additional $20,344 for the Fairfield property, which amount was

treated as an additional loan to Ballard.

The Fairfield Planting Co. is an S corporation which owned

the Fairfield Plantation, a farm in Arkansas. The income and

loss from the Fairfield Plantation Co. were reported on Ballard's

1987, 1988, and 1989 returns.

At the time of trial of these cases, TMT owned the following

farms or other entities: Ashland Plantation in Mississippi,

Fairfield in Arkansas, and Loch Leven in Mississippi. The

Ballards referred to the Loch Leven farm as "our big farm."

According to Mary Ballard, TMT, at one time, had been involved

with Lock Leven, but it was owned by the Ballards.

Mrs. Ballard did not know who owned the stock of TMT. She

referred to TMT as her husband's business.
 - 178 -

Ficom was a sole proprietorship formed by Ballard's daughter

Melinda Ballard in 1983. In 1986, $4,000 from TMT was

transferred to Ficom. In 1988, TMT transferred another $15,000

to Ficom. When the transfer was made, a bookkeeping notation was

also made to write off the investment in 1989. The investment

in Ficom was subsequently written off as worthless in 1989.

d. Lisle: Disposition of Funds out of Carlco

During the years 1982 through 1989, the following

individuals were listed as the "officers" and "directors" of

Carlco:

Title 1982 1983 1984
Directors Kanter Freeman (deleted)
Carl Kanter Meyers
President Carl Kanter Meyers Henry Lisle
Vice president Kanter Donna Lisle
Secretary Meyers Gallenberger D. Dubanevich
Treasurer Meyers Meyers Meyers

Title 1985 1986 1987
Directors None None None
President Henry Lisle Henry Lisle Henry Lisle
Vice president Donna Lisle Donna Lisle Donna Lisle
Secretary Dubanevich Dubanevich Dubanevich
Treasurer Gallenberger Gallenberger
Assistants Meyers Lisle Lisle

Title 1988 1989
Directors None None
President Henry Lisle Robert Lisle
Vice president Donna Lisle Thomas Lisle
Secretary Dubanevich Donna Lisle
Treasurer Gallenberger Gallenberger

During the years 1984 through 1989, moneys from Carlco were

deposited in a brokerage account maintained at Goldman Sachs

(Carlco Goldman Sachs account). The mailing address of the
 - 179 -

Carlco Goldman Sachs account was in care of Robert Lisle, 47

Cheltenham Way, Avon, Connecticut, which was the address of the

Lisle family residence. Lisle, Mrs. Lisle, and Henry Lisle

(Lisle's brother) had signatory authority over this account. The

balance in this account at the end of 1984 to 1988 was as

follows:

Year Goldman Sachs
1984 $113,255
1985 42,362
1986 90,601
1987 70,372
1988 392,252
1989 82,559

During the years 1984 through 1989, other money from Carlco

was deposited into an account in the name of Carlco at the

Hartford Bank in Connecticut (Hartford account). The mailing

address of the Hartford account was in care of Lisle at the Lisle

family residence. Lisle and his wife had signatory authority

over the account. The balance in the account at the end of the

years 1984 through 1988 was as follows:

Year Hartford
1984 $18,198
1985 10,871
1986 211,618
1987 161,573
1988 153,767

On April 12, 1985, Lisle withdrew $3,000 from Carlco's

Hartford account to pay a receivable owed to Administration Co.

by his grantor trust, the RWL Cinema Trust. The payment did not

create a receivable owed to Carlco by RWL Cinema Trust.
 - 180 -

Around 1989, the Lisles moved to Dallas, Texas. During the

year 1989, money from Carlco was deposited in an account

maintained at the North Dallas Bank, Dallas, Texas (North Dallas

account). The mailing address of the North Dallas account was

5519 Bent Trial, Dallas, Texas, which was the address of the

Lisles' Dallas residence. Lisle and his wife had signatory

authority over the North Dallas account. At the end of 1989

there was $123,323 in the account.

e. Kanter: Disposition of Funds out of BWK, Inc.

During the years 1984 through 1989, Kanter and his son,

Joshua Kanter, received a "salary" from BWK, Inc., in the amounts

indicated:

Year Burton Kanter Joshua Kanter
1984 $40,000 --
1985 40,000 $9,000
1986 40,000 13,000
1987 30,000 4,000
1988 30,000 --
1989 30,000 --
Total 210,000 26,000

On April 11, 1985, $400,000 was transferred from BWK, Inc.

to Kanter. The transfer was recorded on BWK, Inc.'s books as a

receivable owed by Kanter. Beginning in 1988, although book

entries continued to show that BWK, Inc., paid Kanter a $30,000

salary, Kanter did not receive the money. Instead, BWK, Inc.,

reduced the $400,000 receivable from Kanter by $30,000 per year.
 - 181 -

4. Loans

a. IRA Loans to Kanter

IRA's records reflect the following amounts transferred to

Kanter and recorded as receivables:
Burton W. Kanter
1982 Beginning balance --
Adj for bal in Cedilla Trust $4,450
Ending balance 4,450
1983 Beginning balance 4,450
Loan repymt. from BWK --
Ending balance
1984 No entry
1985 Beg. balance --
Sold Geochem to BWK 500
Sell TWOOD rec to BWK 10,000
Sold funds for Energy 5,000
Rec sale of assets sold 1,110
Ending balance 16,610
1986 Unexplained acct. total (39,940)
1987 Beg. balance (39,940)
Repay BWK RE H BLUM 219
HB Rpymt (S/B to BWK) (219)
Move to notes payable 39,940
Ending balance --
1988 No entry
1989 Beg. balance --
B. Kanter/Ln 250,000
Unavailable history 350,000
Ending balance 600,000

b. Loans to Ballard, Lisle, Their Family Members and Trusts

Ballard and Lisle established the following grantor trusts,

the income (or losses) of which was includable in Ballard's and

Lisle's income pursuant to sections 671 through 678:
 - 182 -

Date Established Ballard Lisle

10/23/73 CMB Cinema Trust36 RWL Cinema Trust
7/15/75 CMB Cinema Trust II RWL Cinema Trust II
6/03/80 Summit Trust Basking Ridge Trust
11/02/81 Seabright Trust

Mrs. Lisle and/or Lisle's children or descendants were the

beneficiaries of Lisle's grantor trusts, and Kanter and/or

Weisgal were the trustees. Mrs. Ballard and/or Ballard's

children were the beneficiaries of Ballard's grantor trusts, and

Kanter and/or Weisgal were the trustees.

The CMB Cinema Trust and CMB Cinema Trust II, RWL Cinema

Trust, and RWL Cinema Trust II (hereinafter collectively referred

to as the Cinema trusts) each made investments, as limited

partners, in certain movie shelter partnerships. Each trust

financed the acquisition of its movie partnership interest

through loans from IRA and Int'l Films.

The Seabright Corp. was owned by the Mary Family Trust. The

Seabright Corp. owned a farm called Seabright Farm located near

Little Rock, Arkansas. The beneficiaries of the Mary Family

Trust were Mary Ballard and her three daughters. The records of

the Seabright Corp. were maintained at Ballard's residence. Mary

Ballard was an officer of the Seabright Corp.

On May 29, 1976, the CMB Cinema Venture partnership was

formed. The CMB Cinema Trust and the CMB Cinema Trust II were

36
In 1979, the CMB Cinema Trust was divided into 10 separate
trusts.
 - 183 -

partners in the CMB Cinema Venture partnership. As of the end of

1987, CMB Cinema Venture partnership was a shareholder of Int'l

Films.

The movie ventures in which the trusts invested proved

unsuccessful and were not profitable. Substantial losses from

the ventures were reported by Ballard on his income tax returns.

The Internal Revenue Service later disallowed the deductions that

Ballard claimed on his tax returns with respect to these movie

investments. As a result, the Ballards were required to pay

additional taxes. In July 1985, Mrs. Ballard borrowed $160,000

from TMT to pay this income tax liability.

Kanter entities made the following loans to Ballard, his

family members, and entities established for the benefit of his

family members:
 - 184 -

Ballard Loans

Lender Year Distributee Amount

Int'l Films 1974 CMB Cinema Trust $10,000
Int'l Films 1975 CMB Cinema Trust 21,500
Int'l Films 1975 CMB Cinema Trust II 12,500
Int'l Films 1976 CMB Cinema Trust 8,200
Int'l Films 1976 CMB Cinema Trust 19,000
Int'l Films 1976 CMB Cinema Trust II 1,100
Int'l Films 1977 CMB Cinema Trust 2,200
Int'l Films 1977 CMB Cinema Trust II 3,400
Int'l Films 1978 CMB Cinema Trust 3,000
Int'l Films 1978 Ballard 9,500
Int'l Films 1979 Ballard 8,784
HELO 1980 Summit Trust 85,000
HELO 1981 Summit Trust 20,700
Int'l Films 1981 CMB Cinema Trust 4,000
IRA 1982 Ballard 160,400
IRA 1983 Ballard 500
Administration Co. 1983 Seabright Trust 11,300
Administration Co. 1984 Ballard 10,000
Administration Co. 1984 Seabright Corp. 25,840
TMT 1985 Mary Ballard 160,000
Administration Co. 1988 Seabright Corp. 5,000

Kanter entities made the following loans to Lisle, his

family members, and entities established for the benefit of his

family members:
 - 185 -

Lisle Loans

Lender Year Distributee Amount

Int'l Films 1974 RWL Cinema Trust $15,000
Int'l Films 1975 RWL Cinema Trust II 20,000
Int'l Films 1975 Lisle 10,000
Int'l Films 1976 RWL Cinema Trust 5,000
Int'l Films 1976 RWL Cinema Trust II 18,000
Int'l Films 1977 RWL Cinema Trust II 5,000
Int'l Films 1978 Lisle 9,500
Int'l Films 1978 RWL Cinema Trust II 3,750
Int'l Films 1978 RWL Cinema Trust II 4,469
Int'l Films 1979 Lisle 8,784
Int'l Films 1979 RWL Cinema Trust II 3,000
Int'l Films 1980 RWL Cinema Trust II 250
Int'l Films 1981 RWL Cinema Trust II 2,750
Int'l Films 1982 RWL Cinema Trust II 2,320
Int'l Films 1983 RWL Cinema Trust II 3,000
HELO 1983 Basking Ridge Trust 95,000
IRA/Int'l Films 1983 Lisle 3,000
Int'l Films 1984 RWL Cinema Trust II 3,000
Administration Co. 1985 RWL Cinema Trust II 3,000
Int'l Films 1986 RWL Cinema Trust II 3,000
Administration Co. 1987 RWL Cinema Trust II 2,463
IRA 1988 RWL Cinema Trust II 6,000
BWK 1989 RWL Cinema Trust II 3,000
BWK 1990 RWL Cinema Trust II 2,969

5. Writeoff of Loans and Losses

Kanter traded receivables between various entities and used

convoluted bookkeeping entries to eliminate the receivables and

to create bad debt and worthless stock deductions.

IRA distributed $160,400 to Ballard in 1982 and $500 in 1983

and recorded the transfers as receivables owed by Ballard. IRA

immediately transferred the receivables to Int'l Films. IRA's

general ledgers reflected Ballard's receivable account for 1982

and 1983 as follows:
 - 186 -

Claude Ballard
1982 Beg. balance
Record trns Dec 1982 $160,400
Asgn Ballard ln to IFI (160,400)
Ending balance -0-
1983 Beg. balance -0-
TACI E ln for C. Ballard 500
Asgn to IFI ck 1120 (500)
Ending balance -0-

IRA's general ledger showed Int'l Films' receivable for 1982

as follows:

Int'l Films
1982 Beg. balance $70,200
Int'l Films 13,000
Int'l Films 4,000
Int'l Films-loan 1,250
Trans. thru Nov. 1982 7,130
Trans. thru Dec. 1982 5,465
Ballard loan asgn to Int'l Films 160,400
Ending balance 261,445

By the end of 1982, IRA had transferred $1,189,900 to HELO

that was recorded as a receivable owed to IRA by HELO.37 In 1983

HELO had $95,000 receivables owed to it from Lisle's Basking

Ridge Trust and $106,200 from Ballard's Summit Trust.38

In 1983, a transaction took place between IRA, the Bea Ritch

Trusts, Int'l Films, and HELO which had the effect of (1)

37
In 1983, HELO was a subsidiary of Holding Co. On Aug. 31,
1984, Kanter as trustee of the ARO Trusts became the owner of 100
percent of HELO's voting stock.
38
It is not clear from the record whether HELO made the
distributions to the Basking Ridge and Summit trusts during 1983
or at some earlier time.
 - 187 -

increasing the receivables due to IRA from the Bea Ritch Trusts

by $500,000; (2) decreasing IRA's outstanding receivables due

from HELO by $701,200; (3) eliminating HELO's $95,000 receivables

from Lisle's Basking Ridge Trust and $106,200 from Ballard's

Summit Trust; and (4) creating IRA receivables of $95,000 from

the Basking Ridge Trusts and $106,200 from the Summit Trust.

IRA's general ledger and adjusting journal entries reflected the

effect of the transfers on receivables owed to it as follows:

HELO Receivables Owed to IRA

1983 Beginning balance $1,189,900
Loan repymt from HELO (11,200)
Part. loan repymt HELO (900)
Repymt frm HELO via BRT1 (500,000)
Lns Bask Rg & Summit via HELO (201,200)
Ln fm FIN Acq. via HELO 33,500
Ending balance 510,100
1
No actual payment was made. Instead the receivable due
from Bea Ritch Trusts was increased by $500,000.

Summit Trust Receivables Owed to IRA

1983 Beg. balance -0-
Ln rpymt from Summit ($10,100)
Lns BSK RG & SMT via HELO 106,200
Asgn SMT & BSK RG to IFI (96,100)
Ending balance -0-
Basking Ridge Trust Receivables Owed to IRA

1983 Beg. balance -0-
Ln rpymt Frm Bask Rdg ($10,300)
Lns BSK RG & SMt via HELO 95,000
Asgn SMT & BSK RT to IFI (84,700)
Ending balance -0-
 - 188 -

1983 AJE 9 - To adj. for loans made to Basking Ridge & Summit via
HELO (remove HELO from middle)
Debit Credit
1191-0256 Due from Basking Ridge 95,000
1191-0255 Due from Summit 106,200
1191-032 Due to HELO (201,200)

1983 AJE 26 To record transfer of receivables from Basking Ridge
& Summit to IFI on 10/31/83)
Debit Credit
1191-0121 Due from IFI 180,800
1191-0255 Due from Summit (96,100)
1191-0256 Due from Basking Ridge (84,700)
Int'l Films Receivables Owed to IRA

1983 Beg. balance 261,445
Loan to Int'l Films 1,400
Loan to Int'l Films 1,000
IF- loan on behalf of R Lisle 3,000
Loan to Int'l Films 100
Loan to Int'l Film 200
Loan to Int'l Film 100
Loan repymt from Int'l Films (1,000)
Loan repymt from Int'l Films (500)
Loan repymt from Int'l Films (325)
Loan repymt from Int'l Films (700)
Asgn. to Int'l Films1 500
Asgn Summit and Basking Ridge Int'l Films2 180,800
Asgn 1984 Devlp to Int'l Films3 86,400
Acct. Total 532,420
1
Check
#1120 - Administration Co. loan for C. Ballard $500.
2
1983 AJE 26 - to record transfer of receivables from
Basking Ridge & Summit to Int'l Films on 10/31/83.
3
1983 AJE 28 - to record assignment of interest in 1984
Development to Int'l Films on 10/31/83.

In essence, IRA obtained HELO's receivable due from Basking

Ridge and Summit. Simultaneously with this book entry

transaction, IRA transferred to Int'l Films the $180,800 balance

of the receivables due from Basking Ridge and Summit that it had

just obtained from HELO and in exchange, IRA entered on its books
 - 189 -

a receivable due from Int'l Films for the amount of the Summit

and Basking Ridge receivables, $180,800, $201,200 less a credit

of $10,300 that was treated as a "loan repayment" from Basking

Ridge, and $10,100 credit for a "loan repayment" from Summit.

The sources of the credits are not shown in the record. In

addition to the receivables, IRA transferred to Int'l Films its

interest in a partnership called 1984 Development valued at

$86,420.

In 1987, receivables were again reshuffled. On December 17,

1987, Int'l Films' records reflected receivables owing by

Ballard, Lisle, and their trusts totaling $582,682, as shown

here:

Int'l Films Receivables
Ballard $35,784
Ballard 160,900
CMB Cinema 70,650
CMB II 16,675
Summit 96,100
CMB Cinema Ventures 250
Subtotal 380,359
Lisle 28,284
RWL Cinema 21,500
RWL II 67,839
Basking Ridge 84,700
Subtotal 202,323
Total 582,682

On December 17, 1987, Int'l Films had additional receivables

totaling $538,243 owing by the following entities in the amounts

shown:
 - 190 -

Entity/Individual Amount
Safari Trust $98,450
HGA Cinema 133,695
Elk Invest. 76,500
Inter Alia 125,000
Hargen 8,000
Holding Co. 29,500
Abernathy 67,098
Total 538,243

Although the record does not contain a complete history of

the outstanding receivables, the record does disclose the

following loans made by Int'l Films through April 1981:

Inter Alia Investments
10/26/73 $140,000
12/16/77 Principal payment (10,000)
03/27/78 Principal payment (5,000)
Balance 125,000

Elk Investment
11/09/76 76,500

Claude M. Ballard
07/27/78 9,500
08/14/79 8,784
Balance 18,284

CMB Cinema Trust
10/29/74 10,000
12/23/75 21,500
04/12/76 8,200
05/27/76 19,000
12/16/77 2,200
11/01/78 3,000
04/81/81 4,000
Balance 67,900

CMB Cinema Trust II
09/29/75 12,500
08/25/76 1,100
12/16/77 3,400
Balance 17,000
 - 191 -

Robert W. Lisle
10/31/75 10,000
07/27/78 9,500
03/14/79 8,784
Balance 28,284

RWL Cinema Trust
10/29/74 15,000
05/27/76 5,000
Balance 20,000

RWL Cinema Trust II
11/25/75 20,000
04/12/76 18,000
12/16/77 5,000
11/01/78 3,750
03/28/78 4,469
01/04/79 3,000
02/07/80 250
02/23/81 2,750
Balance 57,219

HGA Cinema Trust
12/23/75 52,200
04/12/76 17,000
05/27/76 37,125
03/14/79 5,000
11/08/79 3,500
01/08/80 100
Balance 114,925

Safari Trusts
12/23/75 33,800
06/15/76 64,000
Balance 97,800

Hargen
07/27/76 8,000

Harold G. Abernathy (stockholder)
05/10/74 45,000
09/11/74 20,000
01/06/75 40,000
Dividend
08/31/74 (11,238)
08/31/75 (7,878)
08/31/76 (18,786)
Balance 67,098
 - 192 -

Although some of the receivables indicated an interest rate,

there is no evidence that any interest was ever paid, and the

outstanding balances were never increased to reflect accruing

interest.

In 1987, IRA held 1,500 shares of stock in Int'l Films.

IRA's basis in the Int'l Films stock was $65,000. Additionally,

in 1987, IRA had a $507,648 receivable owing to it by Int'l

Films.

Int'l Films' trial balance sheet for the taxable year ending

8/31/87 showed the following:

Assets
Receivables
Safari Trust $98,450
CMB Cinema Trust 70,650
CMB Cinema Trust II 16,675
RWL Cinema Trust 21,500
RWL Cinema Trust II 67,839
HGA Cinema Trust 133,695
Elk Investment 76,500
Inter Alia 125,000
Hargen 8,000
HELO1 180,800
Ballard 35,784
Ballard II 160,900
Lisle 28,284
HGA Cinema Trust 67,098
CMB Cinema Venture 250
Holding Co. 29,500
Total receivables 1,120,925
Other assets
1984 Development Partnership 55,288
Other taxes 80
Total assets 1,176,293
Liabilities
Cash deficit 60
IRA 507,648
I&F Corp. 774
Total liabilities 508,482
 - 193 -

Stockholder equity
Preferred 150
Common 606
Paid-in capital 655,889
Retained earnings 11,167
Total equity 667,812
1
Int'l Films received the HELO receivable in exchange for
the Summit Trust receivable of $96,100 and Basking Ridge Trust
receivable of $84,700.

IRA advanced $60 to cover Int'l Films' cash deficit and

increased the receivable owed by Int'l Films from $507,648 to

$507,708. On December 17, 1987, IRA canceled the $507,708

receivable due from Int'l Films in exchange for (1) the interest

in 1984 Development partnership valued at $55,28839 plus (2)

$1,120,925 of receivables. IRA had transferred the interest in

1984 Development partnership to Int'l Films in 1983. Thus the

notes and partnership interest that Int'l Films transferred to

IRA constituted all of Int'l Films' assets.

IRA apportioned the $507,708 basis in the Int'l Films

receivable among the receivables transferred to IRA from Int'l

Films and the interest in the 1984 Development, Ltd.,

partnership interest as follows (balance differences are due to

rounding):

39
IRA had transferred the interest in the 1984 Development
partnership as part of the 1983 writeoff. The value of the
interest for that transfer was $86,400.
 - 194 -

Basis Weighted Basis Int'l Films
Receivable Int'l Films Average IRA Writeoff

Safari $98,450 8.37 $42,495 $55,955
CMB Cinema 70,650 6.01 30,513 40,137
CMB Cinema II 16,675 1.42 7,209 9,466
RWL Cinema 21,500 1.83 9,291 12,209
RWL Cinema II 67,839 5.77 29,295 38,544
HGA Cinema 133,695 11.37 57,726 75,969
Elk Invest. 76,500 6.50 33,001 43,499
Inter Alia 125,000 10.63 53,969 71,031
Hargen 8,000 0.68 3,452 4,548
HELO 180,800 15.37 78,035 102,765
Ballard 196,684 16.72 84,889 111,795
Lisle 28,284 2.40 12,185 16,099
Abernathy 67,098 5.70 28,939 38,159
CMB Cin. Vent. 250 0.02 102 148
Holding Co. 29,500 2.51 12,743 16,757
1984 Pship. 55,288 4.70 23,862 31,426
Total 1,176,213 100 507,706 668,507

IRA immediately sold the partnership interest in 1984

Development, Ltd., for $1,000 and 10 of the notes (HELO, Safari, CMB

Cinema Trust, CMB Cinema Trust II, RWL Cinema Trust, RWL Cinema

Trust II, HGA Cinema Trust, Elk Investment Partnership, Inter Alia,

and Hargen) for $1 each to another Kanter entity, MAF, Inc. (MAF),40

and IRA claimed capital losses on the sale or exchange of such

notes.

As reflected by a memorandum dated July 17, 1987, Freeman

(IRA's president) and Gallenberger agreed that the loans IRA was

holding that had been made to Ballard and Lisle, individually, and

to their respective grantor trusts would be "forgiven". IRA claimed

bad debt deductions with respect to the Ballard notes, the Lisle

40
MAF was a wholly owned subsidiary of Computer Placement
Services, Inc. (Computer Placement Services).
 - 195 -

note, and the Abernathy note. IRA's worksheet reflects all of the

1984 sales by IRA of these various interest and accounts as set

forth in the following table:

IRA Worksheet Sale Basis Loss on
Price Average Sale

Safari $1 $42,495 $42,494
CMB Cinema 1 30,513 30,512
CMB Cinema II 1 7,209 7,208
RWL Cinema 1 9,291 9,290
RWL Cinema II 1 29,295 29,294
HGA Cinema 1 57,726 57,725
Elk Invest. 1 33,001 33,000
Inter Alia 1 53,969 53,968
Hargen 1 3,452 3,451
HELO 1 78,035 78,034
10 344,990 334,978

1984 Develop. 1,000 23,862 22,862
1,010 368,850 367,840

Ballard 84,888 84,888
Lisle 12,185 12,185
Abernathy 28,939 28,939
126,012 126,012

CMB Cinema
Vent. 102
Holding Co. 12,743
12,845

Total 507,708 493,852

On December 31, 1987, IRA sold its Int'l Films stock to

Gallenberger for $1. In addition to receiving the Int'l Films

stock, Gallenberger was also given $3,000. As a result of the

transactions, IRA claimed the following losses on its 1987

return: (1) A $65,000 long-term capital loss on 1,500 shares of

Int'l Film stock acquired October 2, 1976, with a basis of
 - 196 -

$65,000 and sold for a price of $zero; (2) a $22,862 long-term

capital loss on its investment in 1984 Development, Ltd.,

partnership interest acquired in 1982 having an adjusted basis of

$23,962 and a selling price of $1,000; (3) a $132,013 bad debt;

(4) a $1,176,670 loss on business notes.

The IRA general ledger for January 1 to December 31, 1987,

shows the following transactions with respect to the receivables:

Holding Co.
Unavailable history $64,000
Assets from Int'l Films ADJ 12 12,743
New balance 76,743

Int'l Films
Unavailable history 507,648
Int'l Films/loan 10/20/87 60
Payment from Int'l Films AJE 08 (507,708)
New balance 0

HELO
Unavailable history 485,825
Sell N/R to MAF ADJ 32 (485,825)
Payment from Int'l Films ADJ 08 114,870
Sold to MAF ADJ 09 (114,870)
Int'l Films on amts owed ADJ 10 (7,433)
MAF purchase HELO N/R (1)
Assets from Int'l Films ADJ 12 7,433
ADJ CR ADJ 24 1
New balance 0

Safari Trust
Payment from Int'l Films ADJ 08 62,550
Sold to MAF ADJ 09 (62,550)
Int'l Films on amts owed ADJ 10 (4,048)
Assets from Int'l Films ADJ 12 4,048
New balance 0

CMB Cinema Trust
Payment from Int'l Films ADJ 08 44,887
Sold to MAF ADJ 09 (44,887)
Int'l Films on amts owed ADJ 10 (2,905)
Assets from Int'l Films ADJ 12 2,905
New balance 0
 - 197 -

CMB Cinema Trust II
Payment from Int'l Films ADJ 08 10,594
Sold to MAF ADJ 09 (10,594)
Int'l Films on amts owed ADJ 10 (686)
Assets from Int'l Films ADJ 12 686
New balance 0

RWL Cinema Trust
Payment from Int'l Films ADJ 08 13,660
Sold to MAF ADJ 09 (13,660)
Int'l Films on amts owed ADJ 10 (884)
Assets from Int'l Films ADJ 12 884
New balance 0

RWL Cinema Trust II
Payment from Int'l Films ADJ 08 43,101
Sold to MAF ADJ 09 (43,101)
Int'l Films on amts owed ADJ 12 (2,789)
Assets from Int'l Films ADJ 10 2,789
New balance 0

HGA Cinema Trust
Payment from Int'l Films ADJ 08 84,942
Sold to MAF ADJ 09 (84,942)
Int'l Films on amts owed ADJ 12 (5,497)
Assets from Int'l Films ADJ 10 5,497
New balance 0

Elk Investment
Payment from Int'l Films ADJ 08 48,604
Sold to MAF ADJ 09 (48,604)
Int'l Films on amts owed ADJ 10 (3,145)
Assets from Int'l Films ADJ 12 3,145
New balance 0

Inter Alia
Payment from Int'l Films ADJ 08 79,418
Sold to MAF ADJ 09 (79,418)
Int'l Films on amts owed ADJ 10 (5,139)
Assets from Int'l Films ADJ 12 5,139
New balance 0

Steve Hargen
Payment from Int'l Films ADJ 08 5,083
Sold to MAF ADJ 09 (5,083)
Int'l Films on amts owed ADJ 10 (329)
Assets from Int'l Films ADJ 12 329
New balance 0
 - 198 -

Claude Ballard
Assets from Int'l Films ADJ 12 84,889
W/O worthless notes ADJ 28 (84,889)
New balance 0

Robert Lisle
Assets from Int'l Films ADJ 12 12,185
W/O worthless notes ADJ 28 (12,185)
New balance 0

Harold Abernathy
Assets from Int'l Films ADJ 12 28,939
W/O worthless notes ADJ 28 (28,939)
New balance 0

CMB Cinema Venture
Assets from Int'l Films ADJ 12 102
New balance 102

Invest in 1984 Development partnership
Int'l on amounts owed ADJ 10 32,854
Sold to MAF ADJ 11 (32,854)
New balance 0

Invest in Int'l Films
Unavailable history 65,000
Int'l Films stock worthless ADJ 34 (65,000)
New balance 0

Loss on sale of note receivable
Sold to MAF ADJ 09 507,608
Assets from Int'l Films ADJ 12 (162,721)
Sell N/R $1 not $10 ADJ 23 90
Sell N/R to MAF ADJ 32 831,692
New balance 1,176,670

Loss on worthless securities
Int'l Films stock worthless AJE 34 65,000
New balance 65,000

Loss on sale of 1984 Development Partnership
Sold to MAF ADJ 11 31,854
Assets from Int'l Films ADJ 12 (8,992)
New balance 22,862

Bad Debts
W/O worthless notes AJE 28 126,012
N/R-Forest worthless AJE 33 6,000
New balance 132,013
 - 199 -

The following journal entries demonstrate the convoluted

accounting Kanter engaged in to record the transactions on its

books:

AJE 08: To record payment of Int'l Films $507,708 receivable

by receipt of 10 receivables from Int'l Films:

Debit Credit

N/R Safari Trust $62,550
N/R CMB Cinema Trust 44,887
N/R CMB Cinema Trust II 10,594
N/R RWL Cinema Trust 13,660
N/R RWL Cinema Trust II 43,101
N/R HGA Cinema Trust 84,942
N/R Elk Inv. 48,604
N/R Inter Alia 79,418
N/R Hargen, Karen & Steve 5,083
N/R HELO 114,870
N/R Int'l Films $507,708
 - 200 -

AJE 09: To record the sale of the 10 receivables to MAF for $10

each:

Debit Credit

Due from MAF $100
Loss on sale of notes rec. 507,608
N/R Safari Trust $62,550
N/R CMB Cinema Trust 44,887
N/R CMB Cinema Trust II 10,594
N/R RWL Cinema Trust 13,660
N/R RWL Cinema Trust II 43,101
N/R HGA Cinema Trust 84,942
N/R Elk Inv. 48,604
N/R Inter Alia 79,418
N/R Hargen, Karen & Steve 5,083
N/R HELO 114,870

AJE 23: To reduce the sale price of the receivables from $10 each

to $1 each:

Debit Credit

Loss on sale of N/R $90
Due from MAF $90

AJE 10: To record the receipt of Int'l Films' 1984 Development

partnership interest by adjusting the 10 receivables transferred

from Int'l Films and sold to MAF creating "negative" receivables:

Debit Credit

Investment in 1984 Dev. Pship $32,854
N/R Safari $4,048
N/R CMB Cinema Trust 2,905
N/R CMB Cinema Trust II 686
N/R RWL Cinema Trust 884
N/R RWL Cinema Trust II 2,789
N/R HGA Cinema Trust 5,497
N/R Elk Inv. 3,145
N/R Inter Alia 5,139
N/R Hargen 329
N/R HELO 7,433
 - 201 -

AJE 11: To record the sale of the 1984 Development partnership

interest to MAF for $1,000:

Debit Credit

Due from MAF $1,000
Invest. in 1984 Dev. pship $32,854
Loss on sale 1984 Dev. Ltd. 31,854

AJE 12: To again adjust assets from Int'l Films (1) to record

receivables from Ballard, Lisle, Abernathy, CMB Cinema Venture,

and Holding Co. and (2) to eliminate the 10 "negative"

receivables, by reducing the amount of the loss on the sale of

the 10 receivables to MAF by $162,721 and reducing the amount of

the loss on the sale of the 1984 Development partnership interest

by $8,992:

Debit Credit

Loss on sale of N/R $162,721
Loss on sale of Pship 1984 Dev. 8,992
N/R Claude Ballard $84,889
N/R Robert Lisle 12,185
N/R Harold Abernathy (HGA) 28,939
N/R CMB Cinema Venture 102
N/R Holding Co. 12,743
N/R Safari 4,048
N/R CMB Cinema Trust 2,905
N/R CMB Cinema Trust II 686
N/R RWL Cinema Trust 884
N/R RWL Cinema Trust II 2,789
N/R HGA Cinema Trust 5,497
N/R Elk Inv. 3,145
N/R Inter Alia 5,139
N/R Hargen 329
N/R HELO 7,433
 - 202 -

AJE 28: To write off Ballard, Lisle, and Abernathy receivables as

bad debts:

Debit Credit

Bad debts $126,012
N/R Claude Ballard $84,889
N/R R. Lisle 12,185
N/R H. Abernathy 28,939

IRA computed the loss on sale of notes receivable from Int'l

Films sold to MAF:

Sold to MAF ADJ 09 $507,608
Assets from Int'l Films ADJ 12 (162,721)
SL N/R $1 not $10 AJE 23 90
Loss on return 344,887

IRA computed the money loss on sale of 1984 Development as

follows:

Sold to MAF ADJ 11 $31,854
Assets form Int'l Films ADJ 12 (8,992)
Loss on return 22,862

The adjusting journal entries and losses reported on IRA's

return are summarized in the following chart:
 - 203 -
RECEIVABLES

OWED TO INT’L FILMS
AJE 8 AJE 9 AJE 23 AJE 10 AJE 11 AJE 12 AJE 28
($62,550) $62,550 $4,048 ($4,048)
SAFARI $98,450 (44,877) 44,877 2,905 (2,905)
CMB CIN 70,650 (10,594) 10,594 686 (686)
CMB CIN II 16,675 (13,660) 13,660 884 (884)
RWL CIN 21,500 (43,101) 43,101 2,789 (2,789)
RWL CIN II 67,839 (84,942) 84,942 5,497 (5,497)
HGA CIN 133,695 (48,604) 48,604 3,145 (3,145)
ELK INV 76,500 (79,418) 79,418 5,139 (5,139)
INTER ALIA 125,000 (5,083) 4,083 329 (329)
HARGEN 8,000 (114,870) 114,870 7,433 (7,433)
HELO 180,800 (507,708) 507,870
799,109

BALLARD 196,684 (84,889) $84,889
LISLE (12,185) 12,185
28,284 (28,939) 28,939
ABERNATHY 67,098 (102)
CMB CIN VEN (12,743)
250
HOLDING CO.
29,500
321,816 (32,855) $32,854

Total 1,120,925

1984 Devl 55,288 $507,708

Total 1,176,213 ($100) $90 (1,000)
(507,608) (90) 162,720
Int'l Films receivable (31,854) 8,992

Due from MAF
Loss on sale receiv
Loss on sale pship

Bad debts (126,013)
 - 204 -

In addition to the HELO note acquired from Int'l Films, IRA

had another $485,825 receivable owed by HELO.41 This second note

was also sold to MAF along with a $345,869 note receivable from

Cedilla Investment Co., one of IRA's subsidiaries, for $1 each,

resulting in an additional $831,692 loss. As of August 31, 1987,

Holding Co. had total assets of $11,552,887. Holding Co. had the

resources to pay either IRA or Int'l Films when the receivable

was written off.

In addition to the receivables MAF purchased from IRA, MAF

purchased from Kanter for $27,949, a $311,878 promissory note

owing by Victorian Village and a $23,356 promissory note from S.

Block for $1. Kanter sold these promissory notes to MAF to

create a $307,284 loss for tax purposes. By selling the notes,

Kanter claimed the loss as having been realized by way of a sale

or exchange rather than as bad debt losses.

MAF neither inquired into nor independently ascertained the

value of the purchased promissory notes. MAF did not examine and

consider a particular note's collectibility or the

creditworthiness of its maker or obligors. MAF later wrote off

the notes as uncollectible.

By the end of 1987, neither Ballard nor Lisle owed any

portion of their original "loans" totaling $196,648 and $28,284,

41
By Sept. 1, 1985, HELO was no longer a subsidiary of Holding
Co.
 - 205 -

respectively, to either IRA or Int'l Films. CMB Cinema Ventures

no longer owed $250 to either IRA or Int'l Films. Likewise,

Ballard's and Lisle's grantor trusts' original "loans" totaling

$357,464 were no longer owed to IRA or Int'l Films.

In 1987, Ballard reported $2,400,252 total income on his

Federal income tax return. Included in the $2,400,252 was

$212,309 interest and dividend income and $1,018,367 capital gain

income. In 1987, Ballard had the resources to pay either IRA or

Int'l Films the "loans" owing by him and his grantor trusts. In

1987, when IRA wrote off Ballard's "receivable" as worthless,

Ballard did not report the discharge of this indebtedness as

income on his 1987 return or on subsequent returns.

In 1987, Lisle reported $746,923 total income on his Federal

income tax return. Included in the $746,923 was $255,707

interest and dividend income. In 1987, Lisle had the resources

to pay either IRA or Int'l Films the "loans" that he had received

individually and through his trusts. In 1987, when IRA wrote off

Lisle's "receivable" as worthless, Lisle did not report the

discharge of this indebtedness as income on his 1987 return or

subsequent returns. In 1988, the year after IRA wrote off loans

owing by Lisle and his trusts (RWL Cinema, RWL Cinema II, and

Basking Ridge), IRA made another "loan" to the RWL Cinema Trust

in the amount of $6,000. In addition, KWJ, Inc., or Kanter
 - 206 -

continued to "lend" money in 1989 and again in 1990 to Lisle's

RWL Cinema Trust.

Neither Ballard, Lisle nor their trusts paid any interest to

Int'l Films on the "loans" to them which were subsequently

written off as worthless or sold for $1 by IRA. There were no

notes or any other loan documentation evidencing the purported

loans to Ballard, Lisle, and their trusts.

On March 8, 1989, approximately 2 years after Int'l Films

transferred $1,120,889 of "receivables" to IRA, Int'l Films filed

for bankruptcy. At the time of the bankruptcy filing,

Gallenberger was the vice president of Int'l Films and owned 100

percent of its stock. At the time of Int'l Films' bankruptcy,

Int'l Films owed debts to the following creditors:

Creditors Reason Amount
IRS 1984 taxes $5,500
Kanter Legal services 750
Neal Gerber & Eisenberg Legal services 550
Personal Service Corp. Services 700
I&F Corp. Services 775
Total $8,275

Question 15 of the Statement of Financial Affairs for Debtor

Engaged in Business attached to Int'l Films' Voluntary Petition

for Bankruptcy asked:

Accounts and other receivables:

Have you assigned, either absolutely or as security,
any of your accounts of other receivables during the
year immediately preceding the filing of the original
petition herein? (If so, give names and addresses of
assignees)?
 - 207 -

In response to this question, Gallenberger answered "No."

The transfer and write-off of the receivables shown in the

following series of diagrams:

1983 Step 1:
 - 208 -

1983 Step 2:
 - 209 -

1987 Step 1:
 - 210 -

1987 Step 2:
 - 211 -

C. Payments to Holding Co. and Its Subsidiaries

After Ballard and Lisle left Prudential, Lisle began working

for Travelers. Schaffel paid IRA $213,750, 50 percent of the

fees he earned from the first Travelers' financing approved by

Lisle. After the first payment, Schaffel failed to pay Kanter on

succeeding projects financed by Travelers. After discussions

with Lisle, Schaffel agreed to make payments to Kanter, but under

a different arrangement. Kanter directed Schaffel to make the

payments to Holding Co. Schaffel paid Holding Co. $600,000 in

1984, $1,160,000 in 1985, and $1,003,500 in 1986 for transactions

with Travelers.

Frey and Essex made the following payments to Holding Co.,

during the years 1981 through 1989:

Year Frey Essex Total
1981 $80,616 –- $80,616
1982 -- $70,538 70,538
1983 16,200 64,125 80,325
1984 113,827 109,013 222,840
1985 256,557 98,325 354,882
1986 -- 65,835 65,835
1987 33,570 98,753 132,323
1988 -- 96,188 96,188
1989 -- 42,332 42,332
Total 500,770 645,099 1,145,879

The following diagram shows the money paid to IRA and

Holding Co. by Schaffel for the Travelers financing transactions,

and by Essex and Frey to Holding Co. and Zion:
 - 212 -

D. Distributions to Kanter

Kanter had funds in both the Administration Co. Special E

Account and the Special Account. Administration Co. paid some of

Kanter's business and personal expenses out of Kanter's funds in

these accounts. During 1982 Kanter received the following

amounts from the payers or sources indicated:

Payer/Source Funds Received
Holding Co. $787,129
Computer Placement Service 40,000
Special E Account 190,078
Special Account 286,000
Total $1,303,207

In 1983, Administration Co. paid $143,489 in employee

compensation and distributed over $500,000 as nonemployee

compensation, including $400,000 to the Rainbow Trusts (Rainbow

Trust Nos. 1-25). Prior to 1987, Administration Co.'s assets

consisted primarily of cash and receivables. For example, for

the years 1983, 1984, and 1986, Administration Co. listed the

following assets on its tax returns:
 - 213 -

Fiscal Cash Current Assets Total
Year on Hand (Notes Receivable) Assets
6-30-83 $77,735 $ 998,118 $1,117,457
6-30-84 23,941 4,501,125 4,577,701
6-30-86 55,821 4,365,144 4,512,704

Some of Administration Co.'s receivables represented money

distributed to Kanter or trusts for the benefit of his family.

For example, in 1984, Administration Co. distributed $660,000 to

Kanter that was recorded as a receivable. Administration Co.'s

trial balance for the twelve months ended 6/30/84 reflects the

following notes receivable from Kanter and his grantor trusts:

Entity Amount
Everglades Trust 1-5 $23,595
Everglades Trust 2 1,000
Everglades Trust 3 1,000
Everglades Trust 4 1,000
Kanter, Burton W. 660,845
Total $687,440

As of January 1, 1987, Kanter's general ledger indicated

that Administration Co. had distributed a total of $1,056,751 to

him. By the end of Administration Co.'s fiscal year ended June

30, 1987, its total assets were as follows:

Fiscal Cash Current Assets Total
Year on hand (Notes Receivable Assets
6-30-87 $ 100 $6,929 $63,880

Administration Co.'s return for the year ended June 30,

1987, was the last return filed for Administration Co. Although

the receivables on Administration Co.'s books decreased, as of

October 31, 1987, Kanter still had an outstanding loan from

Administration Co. in the amount of $1,346,641.
 - 214 -

Administration Co. filed for bankruptcy. Sometime in either

1987 or 1988, during the bankruptcy proceedings, Gallenberger

gave to Kanter Administration Co.'s records, including

Administration Co.'s bank statements and canceled checks and the

records related to Kanter, IRA, and Holding Co. The documents

were never returned by Kanter to Gallenberger. The records would

show the amount of moneys in Administration Co.'s accounts held

for Kanter and the related Kanter entities. Administration Co.'s

bankruptcy was terminated on April 19, 1988.

During Administration Co.'s bankruptcy, a new company called

Administrative Enterprises began its operations. By the end of

the year December 31, 1987, Administrative Enterprises filed its

initial return, which reported cash on hand of $11,548 and

current assets (receivables) of $100.

For each of the years 1979 through 1989, Kanter filed his

individual Federal income tax returns which reported adjusted

gross income and income taxes paid as follows:

Adjusted Gross Income
Year Income (Loss) Tax Paid
1978 ($44,386) $ 1,671
1979 (105,084) –
1980 (155,026) –
1981 (53,614) –
1982 (287,536) –
1983 (819,449) –
1984 (804,482) –
1985 (954,695) –
1986 (1,529,213) –
1987 (2,004,257) –
1988 (1,340,459) –
 - 215 -

1989 (1,331,576) –

Kanter paid no Federal income taxes for an 11-year period,

and only minimum tax in 1978 of $1,671. However, he did pay

self-employment tax for the years 1978 ($1,434), 1979 ($1,855),

1980 ($2,098) and 1983 ($3,338).

E. Examination of Petitioners' Returns

In November 1989, the Internal Revenue Service began an

examination of Kanter's income tax returns. Several years were

under examination.

In connection with the investigation of IRA for 1987, an IRS

agent received documents from Gallenberger and Kanter. The types

of documents which the agent received included financial records,

billings, invoices, expense items and various accounting records

and corporate records. The agent reviewed the records to

determine who the shareholders of IRA were in 1983. The records

indicated that the shareholders of IRA for the year 1983 were:

The Ballard Family Trust; The Lisle Family Trust; Weisgal as

trustee of the Bea Ritch Trust; and Schott. IRA's minute books

reflected that, as of 1984, the only shareholder of IRA was the

Bea Ritch Trusts.

Pursuant to a summons to testify, Ballard was interviewed by

IRS agents in February of 1990 at his residence in Florida. At

the time of the interview, Ballard was not under audit. Ballard

understood that he was not under audit and testified under oath.
 - 216 -

The purpose for the interview was to ask Ballard questions about

Kanter's transactions involving Ballard.

Sometime after the interview, Ballard's and Lisle's returns

also were audited. The group of examining agents auditing the

returns of Kanter, Ballard, and Lisle encountered difficulties

because of the numerous entities related to Kanter involving

transactions with him.

The investigation expanded. The IRS began interviewing more

and more witnesses. By November of 1989, the Criminal

Investigation Division (CID) was conducting an investigation.

In February 1990, Kanter sent letters to Ballard's and

Lisle's children terminating the payments they had been

receiving. In Kanter's letter, he stated that the Ballard and

the Lisle children had not done anything for a number of years

and blamed Freeman for continuing to have paid them. On November

20, 1990, Lisle wrote a letter to Kanter explaining to Kanter the

reasons why he managed Carlco for no compensation. Lisle stated

that there could have been a conflict of interest with Travelers,

and it was "a learning experience managing a municipal bond

fund." He told Kanter that he was going to begin charging a fee

because what he was doing took more of his time. Likewise, after

Ballard was interviewed by the IRS in 1990, Ballard began taking

a salary from TMT.
 - 217 -

By letter dated December 17, 1992, Kanter wrote Ballard

regarding an obligation purportedly due by Ballard to Int'l Films

in the amount of $196,684. In the letter, Kanter requested that

Ballard pay $120,000 in satisfaction of this prior obligation, to

"simply avoid any controversy with me or anyone else." The

$196,684 was the amount that had been written off by IRA as a bad

debt in 1987.

During the audit of Kanter's 1987 and 1988 returns, the IRS

requested information including data pertaining to transactions

with the Five. The documents produced by Kanter during the audit

were in many instances incomplete with many missing pages.

Moreover, no documents pertaining to the $1,345,641 that Kanter

received as a loan from Administration Co. were provided.

Kanter, Ballard, and Lisle did not produce the records sought by

the IRS in connection with the business entities relating to

them. Nor did the IRS receive records voluntarily from any of

the entities that had transactions with them. The records that

were produced generally were relevant only to Schedule A

substantiation items, such as records related to charitable

contributions.

As a result of petitioners' failure to produce documents

voluntarily, the complexity of the transactions involved, and the

number of entities involved, the IRS issued summonses in order to

obtain the necessary documents and information to conduct the
 - 218 -

examination. Numerous summonses were issued to Kanter, Ballard,

and Lisle, as well as to many of the entities involved.

The IRS issued the following summonses to the following on

the dates indicated:

Summons issued to Tax Year Date of Summons
Claude Ballard 1984 July 25, 1991
Linda Gallenberger 1984 January 10, 1991
In the matter of
Claude & Mary Ballard
Linda Gallenberger 1984 January 10, 1991
In the matter of
Robert Lisle & Donna Lisle
Linda Gallenberger 1984 January 10, 1991
In the matter of
Claude & Mary Ballard
Donna Lisle 1984 July 30, 1991
Linda Gallenberger 1984 January 10, 1991
Robert Lisle 1988 July 30, 1991
Linda Gallenberger, Officer 1984 January 10, 1991
Principal Service Corp.
In the matter of
Robert Lisle & Donna Lisle
Principal Service Corp. 1983, October 1, 1990
In the matter of 1985-1988
Burton & Naomi Kanter
Mildred Schott 1983, April 30, 1990
In the matter of 1985-1988
Burton & Naomi Kanter

Summonses were also served on Administrative Enterprises,

Principal Services, Zion, and BK Childrens Trust.

The summons to Ballard dated July 25, 1991, requested, in

part, documents in his possession pertaining to TMT, IRA, and the

Orient Trust.

One of the summonses to Gallenberger dated January 10, 1991,

in the matter of Ballard, requested, in part, documents in her

possession pertaining to TMT, KWJ Co., Sherwood Associates,
 - 219 -

Orient Trust, Essex Hotel Management, and all documents

evidencing loans to and from the Ballards with TMT. The other

summons to Gallenberger dated January 10, 1991, in the matter of

Ballard, requested, in part, documents in her possession

pertaining to IRA, KWJ Co., Sherwood Associates, Essex Hotel

Management, Int'l Films, and all documents evidencing loans to

and from the Ballards with IRA.

The summons to Gallenberger dated January 10, 1991, in the

matter of Lisle, requested, in part, documents in her possession

pertaining to IRA, Int'l Films, KWJ Co., Sherwood Associates,

Essex Hotel Management, and all documents evidencing loans to and

from the Lisles with IRA.

The other summons to Gallenberger dated January 10, 1991, in

the matter of Lisle, requested, in part, documents in her

possession pertaining to Carlco, Christie Trust, KWJ Co.,

Sherwood Associates, and Essex Hotel Management and loans between

Carlco and the Lisles.

The summons to Donna Lisle dated July 30, 1991, requested,

in part, documents in her possession as officer of Carlco

pertaining to Carlco, IRA, and the Christie Trust.

The summons to Lisle dated July 30, 1991, requested, in

part, documents in his possession pertaining to Carlco, IRA,

Christie Trust, and loans between Lisle and IRA, Carlco, and

Christie Trust.
 - 220 -

The summons to Gallenberger as an officer of Principal

Services dated January 10, 1991, requested, in part, documents in

Principal Services's possession pertaining to Carlco, Christie

Trust, and loans related to Lisle.

The summons to Principal Services dated October 1, 1990,

requested, in part, documents pertaining to Principal Service

Corporation, IRA and its subsidiaries, Holding Co. and its

subsidiaries, BWK, Inc., and the Bea Ritch Trusts. The summons

requested production of the cash receipts, cash disbursement

journals, general ledgers and ledgers for all bank accounts

including the Special E account. The summons also requested

production of documents pertaining to any corporation or

partnerships in which Kanter, his family or family trusts were

shareholders.

The summons to Schott dated April 30, 1990, requested, in

part, documents pertaining to Cedilla Company, IRA and its

subsidiaries, Kanter, Ballard, Lisle, Schaffel, Frey, Weaver, KWJ

Corp., Motor Hotel Management Inc., Essex Hotel Management Co.,

and Schnitzer-PMS.

The documentation sought in the summonses served on

petitioners, Principal Services, Linda Gallenberger on behalf of

Principal Services, and Mildred Schott was relevant to the issues

in these cases. Petitioners, Gallenberger, Principal Services,

and Schott did not voluntarily turn over documents and
 - 221 -

information listed on the summonses to the agents during the

audit.

None of the above information requested was produced

pursuant to the summonses. In fact, petitioners did not produce

anything in response to the summonses, including documents

evidencing loans between themselves and the various entities.

Principal Services maintained Kanter's personal records, the

records of his family entities and trusts, the records of IRA and

Holding Co. Kanter controlled Principal Services and

Gallenberger. During discovery in these cases, respondent

requested receipts and disbursement journals for Holding Co. for

all of the years at issue. Kanter first promised to produce

Holding Co.'s books and records in the possession of Principal

Services and then, in early February 1994, notified respondent

that the Holding Co. was a third-party over which he had no

control. Initially, Gallenberger had in her possession the

records of Holding Co. for the years 1986, 1987, and 1988. After

respondent requested production of the Holding Co. records,

Kanter never asked Gallenberger for them. At some point,

however, she turned those records over to Kanter.

On April 1, 1994, the Government sought enforcement of four

summonses that had been served in 1990 and 1991 on Administrative

Enterprises, Principal Services, Zion, and BK Childrens Trust

(which is one of the twenty-five trusts which comprise the Bea
 - 222 -

Ritch Trust group). See United States v. Administration Co., 74

AFTR 2d 94-5252, 94-2 USTC par.50,479 (N.D. Ill. 1994). On April

4, 1994, the District Court issued an order to show cause why the

Kanter-related entities should not be compelled to obey the four

summonses.

In connection with the instant cases, Gallenberger was

served by respondent with a discovery subpoena to produce

documents. On May 18, 1994, Gallenberger appeared at the

deposition without the requested documents. At the deposition,

Gallenberger stated that she did not have the records because of

a 3-year retention policy. Even under Gallenberger's alleged

records retention policy, however, documents of an individual or

entity under audit were not destroyed until the audit was

completed.

On the following day, May 19, 1994, a hearing was held in

the District Court on the Government's motion to enforce the

administrative summonses. At the hearing, Weisgal, who was

served as the named trustee of the BK Childrens Trust, admitted

that, after he received the summons, some of the documents,

including documents relating to the Kanters, had been turned over

to Administration Co. and that some had been discarded as part of

a 3-year record retention and discard policy.

Gallenberger, who had been served with summonses as

president of Administration Co., Principal Services, and
 - 223 -

Administrative Enterprises, also admitted at the hearing that she

disposed of some documents after she received the IRS summons and

claimed that documents relating to Administration Co. were never

returned to her from bankruptcy counsel.42 On May 20, 1994, the

District Court ordered the records sought by the summonses be

produced to the IRS by May 24, 1994. United States v.

Administration Co., 74 AFTR 2d 94-5252, 94-2 USTC par. 50,480

(N.D. Ill. 1994).

Although Gallenberger appeared, testified, and produced

some documents on May 24, 1994, in accordance with the District

Court's order, she did not search all of the approximately 52

filing cabinets of records in her possession, but instead looked

in every fifth or seventh file. The Government filed another

motion on June 10, 1994, and, on June 22, 1994 a hearing was

held. See United States v. Administration Co., 74 AFTR 2d 94-

5256, 94-2 USTC par. 50,480 (N.D. Ill. 1994). At this second

hearing, Gallenberger admitted that Principal Services operated

42
During the bankruptcy proceeding for Administration Co., the
only documents that bankruptcy counsel for Administration Co. may
have received from Administration Co. were copies of its tax
returns. He received none of the books and records of the
clients of Administration Co. The documents sought by the
summons which was the subject of the summons enforcement
proceeding did not ask for the tax returns of Administration Co.
The summons sought the books and records relating to transactions
involving the Kanters for the years 1983, 1985, 1986, 1987 and
1988. These records were not given to the bankruptcy counsel.
They were given to Kanter.
 - 224 -

much like a registered agent and a document repository, but

existing primarily for the Kanters' benefit. Gallenberger knew

that most of the documents held by Principal Services were

related to Kanter entities. The District Court 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 held Gallenberger in contempt of court and granted her

until July 1, 1994 to comply fully with the court's order. Id.

at 5258, 94-2 USTC ¶50,480 at 85,770. Gallenberger complied with

the District Court's order of June 22, 1994, but appealed the

order to the Court of Appeals for the Seventh Circuit. The Court

of Appeals affirmed the District Court's order in United States

v. Administrative Enters., Inc., 46 F.3d 670 (7th Cir. 1995).43

The trial of these cases commenced on June 13, 1994. At the

start of the trial, respondent's counsel indicated that subpoenas

duces tecum had been served on various entities for documents

that were to be produced at that time. Counsel for IRA and

Kanter informed the Court that the subpoenas requesting documents

from IRA, BWK, Inc., Carlco, and TMT had been served on

Gallenberger, but that Gallenberger was not the custodian of the

43
The Court of Appeals stated: "It is apparent that the
Government is interested in transactions in which Kanter and his
family and their investment vehicles are involved and not just in
the terms of the custodianship arrangement." United States v.
Administrative Enters., Inc., 46 F.3d 670, 673 (7th Cir. 1995).
 - 225 -

records. Rather, Kanter was the custodian of the records.

Respondent immediately served Kanter with a subpoena requesting

records relating to Holding Co. and its subsidiaries, IRA and its

subsidiaries, Carlco, TMT, and BWK, Inc. The subpoena requested

corporate minute books, corporate minutes, articles of

incorporation and all amendments thereto, stock registers, stock

certificates, certificates of authority, bylaws and all

amendments thereto, and all subscription agreements and

agreements thereto. In addition to the books and records,

respondent also requested production of documents reflecting the

ownership of IRA, Holding Co., Carlco, TMT, and BWK.

Specifically, respondent requested production of the following

original documents:

All books, records or other documents evidencing the
ownership of the following entities: IRA, Holding Co.,
Carlco, TMT, BWK, . . . including but not limited to
stock ledgers and records of stockholders.

Although Kanter produced some documents, many records were

not produced. Absent from the record are resolutions by the

board of directors of Carlco and TMT setting forth the

preferences of the preferred stock.

With respect to Holding Co., Kanter produced Holding Co.

trial balances only for the years 1980 and 1981. Respondent had

from prior audits partial general ledgers of Holding Co. for

1983, 1984, and 1985, and partial trial balances of Holding Co.

for 1983, and 1984. There are no receipts and disbursement
 - 226 -

journals, general ledgers, or trial balances for Holding Co. for

the years 1980, 1981, 1982, 1985 (partial), 1986, 1987, 1988, and

1989. Respondent sought the records because the Five made

payments to Holding Co. during those years.

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.

Gallenberger took the position that a request for documents

in the possession of Principal Services was a request for the

documents of Principal Services, and not the records maintained

by Principal Services for Kanter or Kanter-related entities. She

claimed that Principal Services had a policy of refusing to turn

documents over to anyone other than the owner.

OPINION

By this point, the complexity of these cases is apparent.

That complexity is reflected in the sheer magnitude of the record

and is exacerbated by the contentiousness of the parties. The

trial in these consolidated cases lasted almost 5 weeks, and

produced a transcript of 5,411 pages. The parties' combined

briefs contain 4,668 pages and address over 40 issues. We have

plodded through thousands of exhibits containing hundreds of

thousands of pages. Not surprisingly, our task of finding the

facts has been laborious and frequently frustrating.
 - 227 -

Unless otherwise indicated, references hereinafter to

petitioners are to Ballard, Lisle, and Kanter, collectively.

I. Position of the Parties

Respondent contends that the payments made by the Five to

the various Kanter entities were kickbacks paid to petitioners

for their influence and assistance in acquiring business with

Prudential, Travelers, and others. Specifically, respondent

alleges that (1) when Ballard and Lisle were employed by

Prudential, petitioners received kickbacks from the Five that

petitioners agreed to split 45 percent each to Ballard and Lisle

and 10 percent to Kanter (the Prudential transactions), (2) when

Lisle worked for Travelers, Lisle and Kanter received kickbacks

that were split 90 percent to Lisle and 10 percent to Kanter (the

Travelers transactions), and (3) Kanter alone received kickbacks

for transactions that were not necessarily related to Prudential

and Travelers (the Kanter transactions).

Respondent contends that the payments constituted income to

petitioners that they failed to report on their Federal income

tax returns. It is asserted that the payments related to the

Prudential transactions are taxable 45 percent each to Ballard

and Lisle and 10 percent to Kanter, the payments related to the

Travelers transactions are taxable 90 percent to Lisle and 10

percent to Kanter, and the payments related to the Kanter

transactions are taxable 100 percent to Kanter. In the
 - 228 -

alternative, respondent asserts that, if any of the payments

related to the Prudential and Travelers transactions are not

taxable to Ballard and Lisle, the payments are taxable 100

percent to Kanter.

Respondent maintains that Kanter, in carrying out the

Prudential and Travelers schemes, routed the kickback payments

through IRA and Holding Co., two entities that he controlled, to

conceal from Prudential and Travelers (Ballard's and Lisle's

employers) the fact that Ballard and Lisle were receiving

kickbacks. As a further part of the Prudential kickback scheme,

respondent argues, Kanter later directed and allocated much of

the kickbacks IRA received from the Five to IRA's subsidiaries,

Carlco, TMT, and BWK, Inc., roughly in accordance with the

respective 45-45-10-percent split agreed to by Ballard, Lisle,

and Kanter. In doing this, respondent claims that Ballard,

Lisle, and Kanter each then controlled and managed his respective

share of the kickbacks from the Prudential scheme. Although

Ballard's and Lisle's purported shares of the kickbacks were not

immediately paid to them, respondent asserts that substantial

funds eventually were either paid out or provided to them and

their families through "loans" and "consulting payments" to their

children.

Respondent argues that IRA, its subsidiaries Carlco, TMT,

and BWK, Inc., and Holding Co. were sham or dummy corporations
 - 229 -

that should not be recognized as separate taxable entities. In

the event the Court decides that the corporations were not sham

or dummy corporations, respondent argues in the alternative that

petitioners are taxable on the income under the assignment of

income doctrine or pursuant to section 482.

Petitioners, on the other hand, dispute respondent's

characterization of such payments as kickbacks and their

attribution to Kanter, Ballard, and Lisle. Petitioners deny that

any kickback schemes existed and contend that the payments from

the Five were properly taxable to IRA, Holding Co., or one of

their subsidiaries. Petitioners contend that all of the payments

were reported on the respective tax returns of IRA and Holding

Co. during the years at issue and that such income was properly

taxable to IRA, Holding Co., and/or their subsidiaries, and not

to Ballard, Lisle, and/or Kanter, as respondent asserts.

Petitioners contend that the corporations were not shams and

that the assignment of income doctrine and section 482 are

inapplicable.

II. Omitted Income

Since all of the payments by the Five were made to entities

associated with and controlled by Kanter, and, from there, the

payments flowed through to Kanter, Ballard, and Lisle, it is

appropriate to consider first whether the payments made to

Kanter's entities are attributable to petitioners, because if we
 - 230 -

conclude that such payments were not attributable to them, it

follows that such payments or portions thereof are attributable

to the entities that received the payments.

A. The Transactions

We begin by examining the transactions at issue.

1. The Hyatt Payments

In a joint venture with others, Prudential built the

Embarcadero Hotel and sought a management company to operate it.

Originally, only Webb and Intercontinental were considered for

the management contract on the hotel. Although Hyatt had

successfully negotiated the management contract for the Houston

Hyatt Hotel, in which Prudential was involved, Lisle was not

interested in having Hyatt bid on the management contract for the

Embarcadero Hotel. Pritzker offered to pay 10 percent of the

management fees to Weaver if he could get Prudential to award the

contract to Hyatt. Weaver then convinced Lisle to allow Hyatt to

bid on the contract.

Representatives of the hotel's owners, including Lisle and

Ballard representing Prudential, then met with Webb and Pritzker

to obtain bids on the management contract. Apparently, since

Intercontinental was not represented at the meeting,

Intercontinental either withdrew or was eliminated from

consideration prior to the meeting. Webb refused to submit a bid

at the meeting because he thought he had previously been promised
 - 231 -

the contract. Hyatt submitted the only bid and was subsequently

awarded the contract. Hyatt then executed a written agreement

with Weaver's KWJ Corp. dated February 25, 1971, pursuant to

which Hyatt agreed to pay KWJ Corp. 10 percent of the management

fees Hyatt earned from management of the hotel. The agreement

acknowledged that "KWJ" was the principal factor in bringing

Hyatt Corp. and the owners of the Embarcadero Hotel together and

aiding in the negotiations.

The hotel opened in May 1973. Apparently, Hyatt did not

make a profit the first year, and no payments were made to KWJ

Corp.

In 1975, a dispute arose between Weaver and Hyatt as to

whether KWJ Corp. was entitled to management fees for 1974. The

dispute was settled in November 1975.

Before the dispute was settled, Weaver and Kanter agreed

that Weaver would sell all the stock of KWJ Corp. to IRA. They

executed an agreement dated March 10, 1976, acknowledging the

agreement. The agreement gave IRA the option to purchase the

stock within 4 years for $150,000 plus an amount equal to 30

percent of all payments received by KWJ Corp. from Hyatt after

the purchase. In September 1979, Kanter informed Weaver that he

wanted to proceed with the purchase of the KWJ Corp. stock. The

sale was made effective retroactively to November 1, 1978.
 - 232 -

Petitioners would have us end our examination of the

transaction at this point and hold that the sale was a valid

arm's-length sale of the stock to IRA. The Court declines to do

so because it would ignore the true substance of the transaction

and give new meaning to the expression "blind justice". We think

the true substance of the transaction is clearly disclosed when

one follows the flow of the money.

The only activity conducted by KWJ Corp. and later the KWJ

Co. partnership, was receiving the Hyatt payments. IRA was to

pay $10,000 of the purchase price in November 1979 and the

balance by August 1980. Hyatt paid over $170,000 to KWJ Corp. in

1979. Thus, IRA simply paid the purchase price from the Hyatt

payments.

After paying 30 percent of each of the Hyatt payments to

Weaver, the remaining funds were (1) distributed as "consulting

fees" to Ballard's and Lisle's children, (2) filtered along with

other payments from the Five through IRA, Int'l Films, and HELO

as loans to Ballard, Lisle, and Kanter, and (3) distributed to

Carlco, TMT, and BWK, Inc. Lisle's control over the Carlco

assets, Ballard's control over the TMT assets, and Kanter's

control over the BWK, Inc. assets went unfettered. Petitioners

had unrestricted power to use the funds for their personal

benefit and in fact did so.
 - 233 -

The record clearly and convincingly shows that Weaver agreed

to split his Hyatt commissions with Ballard and Lisle in exchange

for their influence in having the management contract awarded by

Prudential and its co-owners to Hyatt. The record also shows by

clear and convincing evidence that Lisle and Ballard agreed to

pay Kanter 10 percent of their share of the payments in exchange

for Kanter’s facilitating the concealment and distribution of the

funds. Additionally, the transfer of the stock to IRA allowed

petitioners to offset the income from the Hyatt payments with

tax-shelter losses claimed on IRA's consolidated returns. The

entire arrangement was implemented in order to conceal Ballard's

and Lisle's participation from Prudential and Kanter's

participation from Hyatt and to avoid Federal taxes.

When Weaver sent to IRA the 1983 payment from Hyatt for the

management fees earned in 1982, he wrote in the letter dated

March 29, 1983: "Will you please deposit and issue appropriate

checks to the participants." If there was no agreement to split

the fees with petitioners, we think it more likely that Weaver

would simply have directed IRA to remit to him his 30 percent.

KWJ Corp. had not been liquidated; Carlco, TMT, and BWK were not

"active" (no stock had been issued); and the KWJ Co. partnership

had not yet been formed. We are convinced that the reference to

the "participants" was to Ballard, Lisle, and Kanter, as well as

Weaver.
 - 234 -

Petitioners assert that Ballard and Lisle did not have the

power to award the contract to Hyatt in part because their

positions with Prudential did not give them such authority and in

part because there were others besides Prudential participating

in the project. Although Ballard and Lisle may not have been in

a position to guarantee that the contract would be given to

Hyatt, their opinions as Prudential executives would have

influenced the other owners. Certainly a negative opinion with

respect to a bidder would have foreclosed the possibility of the

bidder getting the contract. Strum, CEO of the Prudential Realty

Group for Development and Retail Property Investments, testified

that Ballard had the "hierarchy power" either to influence the

selection of contractors or to prevent a project from going

forward. Initially, Lisle used his "prevention power" to keep

Hyatt even from being considered for the management contract.

Ballard and Lisle may not have had the power to guarantee that

Hyatt would get the contract, but they did have the power to

guarantee that it would not get the contract.

Kanter claims that he did not know about Hyatt's arrangement

with Weaver until Pritzker later asked him about some language in

the agreement. The copies of the correspondence between Weaver

and Hyatt concerning the dispute over the computation of the fees

were copies that Kanter had in his records. He claimed that
 - 235 -

Pritzker gave him the copies in the course of Pritzker's

consulting with him regarding the dispute with Weaver.

The letter acknowledging Weaver's prior understanding that

he would sell all the stock in KWJ Corp. to Kanter's "client"

(IRA) for $150,000 is dated March 10, 1976. Kanter admitted that

he and Weaver had been discussing the sale for some time before

March 10, 1976. At trial he testified that he did not know

whether it was a few months before or a much longer period of

time. Kanter testified that "J.D. [Weaver] needed money and was

clearly unhappy with what might be the interpretation of the

contract in light of his dispute with Abe [Pritzker], and it led

to this letter."

We find Kanter's testimony to be implausible. We find it

incredible that an attorney consulting with a very important

client about a contract dispute would surreptitiously negotiate

with the other party to the contract to purchase essentially the

same contract that was the subject of the dispute and on which

the attorney was giving advice.

We are not convinced that Kanter obtained the copies of

Hyatt's correspondence with Weaver from Pritzker rather than from

Weaver. Kanter was not Hyatt's attorney. He represented the

Pritzker family, but Hyatt had its own attorneys, including

members of the Pritzker family who themselves were attorneys.

Kanter testified that he had very limited involvement with
 - 236 -

respect to the Embarcadero Hotel project and that, although Hyatt

Corp. had full-time tax counsel representing it, there were some

isolated tax questions with which he was involved. He testified

that, at that time, his office did not do anything but tax work

and he had no involvement with any other part of the project or

contract.

Kanter also claims that Weaver gave IRA 4 years to buy the

stock for two reasons: First, because Weaver needed the money,

and, second, because Hyatt was attempting to become privately

owned and Hyatt would not want to disclose the agreement. Kanter

claimed that the reason Hyatt would not want to disclose the

agreement was because others might expect similar fee-splitting

arrangements in negotiating for other projects.

Again, Kanter's explanation is implausible. If Weaver

needed the money, we do not think he would agree to put the sale

off for up to 4 years. Furthermore, Hyatt's contract with KWJ

Corp. already existed. Hyatt either had to disclose its contract

with KWJ Corp. in accordance with the securities laws or it did

not. We fail to see how the sale of the stock to IRA would

affect the disclosure requirement unless IRA was somehow

considered an interested party or an insider with respect to

Hyatt Corp. We think it more likely that Kanter did not want to

disclose the purchase to Hyatt Corp. or the Pritzkers. In fact,

Kanter did not disclose the purchase of the stock, the
 - 237 -

liquidation of KWJ Corp., or the assignment of the contract

rights to the KWJ Co. partnership until sometime around 1992.

Furthermore, there was no reasonable explanation for

Weaver's selling the stock in KWJ Corp. to IRA for $150,000 plus

an amount equal to 30 percent of all payments received by KWJ

Corp. from Hyatt. Weaver was experienced enough to know that the

contract was worth millions of dollars. By selling the stock, he

effectively gave up 70 percent of the contract rights. It would

have been less costly to hire another attorney to represent him

in enforcing the agreement. Moreover, if Weaver had expected

Hyatt to make the payments more readily because of Kanter's

relationship to IRA and the Pritzkers, then Weaver would have

notified Hyatt of the sale of the stock. That he did not do.

Instead, he continued to receive the payments from Hyatt which he

then forwarded to IRA. It is clear that Weaver and Kanter

intentionally concealed the sale of the KWJ Corp. stock from

Hyatt until Kanter's relationship with Weaver deteriorated around

1992.

Similarly, the Court also finds that the "consulting

payments" Kanter arranged to have KWJ Corp., and later the KWJ

Co. partnership, pay to Ballard's and Lisle's children from about

1983 through 1989 were part of the kickback scheme. Although

referred to as "children", they were adults and were all engaged
 - 238 -

in other employment, and no services were performed or expected

of them for these payments.

We hold that the Hyatt payments, less Weaver's 30 percent,

were attributable to services provided by Kanter, Ballard, and

Lisle.

2. The Frey Arrangement

Frey was engaged in the business of converting apartment

complexes into condominiums. Frey agreed to share fees with

Kanter in any project for which Kanter provided investors.

Frey's agreement that he would share development and

management fees with Kanter was formalized in two separate

written agreements each dated October 12, 1981. One agreement

was between Frey and IRA's subsidiary Zeus, and the other

agreement was between Frey and Holding Co.

The written agreement with Zeus covered development fees and

profits shares from all condominium conversions of property of or

for Prudential, including all prior and future conversions. The

agreement did not provide for termination by either party and did

not require Zeus to provide any funds or services.

All of Zeus' income was attributable to the payments from

the Frey corporation, interest income, and income from

partnerships. The commission payments from Frey were unrelated

to Zeus' investment in the partnerships. Zeus did not provide

any capital or services for the commission payments. Frey agreed
 - 239 -

to pay Zeus and made the payments because Kanter used his

influence with Ballard and Lisle, who in turn used their

positions of authority at Prudential to influence Prudential in

using Frey as the developer in the conversion of Prudential

properties into condominiums. The payments were accumulated in

Zeus (or distributed as loans) until 1983. In 1983, Zeus

distributed the funds to IRA. In 1984 IRA distributed the funds

to Carlco, TMT, and BWK, Inc., effectively distributing the funds

45 percent each to Ballard and Lisle and 10 percent to Kanter.

Frey paid Zeus $103,500 in 1984 and $128,763 in 1985 (totaling

$232,263). Although the money was accumulated in Zeus until it

purchased the preferred stock in Windy City in 1986, IRA

distributed $249,870 to the KWJ Co. partnership as "loans" from

1984 to 1989.

It is clear that the payments made by Frey to Zeus were for

services provided by Ballard, Lisle, and Kanter.

The second agreement (between Frey and Holding Co.) applied

to "capital contribution, profits and losses and Developers'

Fees" for all condominium conversions excluding the developers'

fees from Prudential projects that were covered by the agreement

with Zeus. The agreement could be terminated by either party

with 45 days' prior notice with the termination effective only

with respect to new condominium conversions. Although the second

agreement required Holding Co. to make capital contributions with
 - 240 -

respect to Holding Co’s. investment as a partner, it did not

require Holding Co. to make any contributions or provide any

services in exchange for its share of the developer fees at issue

in this case. Furthermore, Holding Co. did not pay for its

partnership interest. Rather, Frey paid the capital

contributions, and Holding Co.'s share of profits was reduced by

a portion of the contributions as the profits were distributed.

Frey paid a portion of his development fees and profit

interest to Holding Co. for Kanter's services of providing other

investors in the projects. Holding Co. did not provide any

services or capital with respect to those fees.

We hold that the payments from Frey to Zeus are attributable

to services provided by Ballard, Lisle, and Kanter, and the

payments to Holding Co. are attributable to services provided by

Kanter.

3. The Schaffel Arrangement

The arrangement between Schaffel and Kanter originated at

the dinner with Ballard and Lisle in New York. At the meeting,

Kanter offered his and "his associates'" help in obtaining deals

from which Schaffel could earn fees as a broker, provided

Schaffel would agree to pay Kanter half of any broker's fees

Schaffel received from the deals. Schaffel agreed, and Kanter

helped Schaffel negotiate agreements with Torcivia and Walters.

Pursuant to those agreements, Torcivia and Walters agreed to pay
 - 241 -

Schaffel 1 percent of the gross amount of the contract price of

any construction contract that Schaffel helped obtain for their

companies. Schaffel then executed a letter agreement to pay 50

percent of the fees he received for construction jobs in which

Kanter or his "associates" had been instrumental or helpful in

obtaining for Torcivia or Walters. Although the letter agreement

is addressed to IRA, it is clear that the agreement was with

Kanter and the reference to associates was to Ballard and Lisle.

As a result of the introduction to Ballard and Lisle,

Schaffel began doing millions of dollars of business with

Prudential, including construction contracts and financing for

Torcivia and Walters, as well as others. From 1979 to 1983,

Schaffel paid IRA $1,184,876 from these Prudential transactions.

After Ballard and Lisle left Prudential, Schaffel stopped

negotiating contracts with Prudential. Instead, he began

negotiating contracts for Torcivia and Walters with Lisle at

Travelers. Schaffel paid IRA $213,750 from the first Travelers

transaction. After that payment, however, Schaffel stopped

paying IRA a share of the fees he earned on Travelers

transactions. When Kanter contacted Schaffel and inquired as to

why Schaffel was not remitting half the fees from Travelers

transactions to IRA, Schaffel claimed that the prior agreement

related to Prudential transactions did not apply to Travelers

transactions. In the August 28, 1984, letter to Schaffel, Kanter
 - 242 -

asserted that the arrangement should continue because, in his

view, Travelers had replaced Prudential as the principal source

of the transactions because of the "very personnel" to whom

Schaffel had been introduced. It is clear that the reference to

personnel was to Ballard and Lisle.

After discussing the situation with Lisle, Schaffel agreed

to resume payments for fees earned on Travelers transactions.

Instead of paying IRA, however, Kanter had Schaffel send the

payments from Travelers transactions to Holding Co.

Ballard and Lisle knew that Kanter had an arrangement with

Schaffel to share in the fees Schaffel earned on certain business

deals, because they were present at the dinner meeting when

Kanter initially proposed and discussed the arrangement with

Schaffel. When Kanter and Schaffel had their dispute over

whether IRA was entitled to a share of Schaffel's fees on

business deals with Travelers, Lisle was concerned that a lawsuit

between the two might cause problems for Lisle with Travelers.

Lisle was concerned because he was involved with the arrangement

and benefited from it.

The payments from Schaffel for the Prudential transactions

were accumulated in IRA until the formation of Carlco, TMT, and

BWK, Inc. In 1984, IRA transferred funds to the three new

corporations in a 45-45-10 ratio, effectively transferring 45

percent to Lisle, 45 percent to Ballard, and 10 percent to
 - 243 -

Kanter. It is clear that payments Schaffel made to IRA were in

part for Kanter's service of introducing Schaffel to Ballard and

Lisle, and that Kanter agreed to share the payments with Ballard

and Lisle in a 45-45-10 split.

Although it is also clear that the payments Schaffel made to

Holding Co. were for Kanter's prior service in introducing

Schaffel to Lisle, the record does not show that the funds flowed

through from Holding Co. to Lisle. The payments at issue do not

include the payments Schaffel made through FPC Subventure. Lisle

included 90 percent of the FPC Subventure payments in the income

reported on his returns. There is no evidence in the record that

Kanter otherwise agreed to share or did share the fees from the

Travelers transactions at issue here with Lisle. Thus, we find

that none of the payments were paid to Lisle for his services.

4. The Schnitzer Arrangement

In 1974, Schnitzer's holding company, Century, purchased

Schnitzer-PMS (Fletcher Emerson at the time) for $1.3 million.

The purchase price was based roughly on five times Fletcher

Emerson's pretax earnings of approximately $250,000.44 At the

time of the purchase, Schnitzer-PMS had been managing a

relatively small number of Prudential's commercial properties.

44
Walter Ross was senior vice president of finance of Century
Development Corp. at the time of Schnitzer's purchase of Fletcher
Emerson. Ross testified that it was customary in the industry to
base the purchase price of a service corporation such as Fletcher
Emerson on the pretax income of the company.
 - 244 -

Schnitzer wanted to expand Schnitzer-PMS' business, including its

business with Prudential. Schnitzer approached Ballard and

offered to give Prudential a 50-percent interest in Schnitzer-

PMS. Prudential declined the offer.

Although the record shows that Ballard introduced Schnitzer

to Kanter sometime between 1971 and 1976, it is not clear whether

the introduction was made before or after Schnitzer proposed to

give Prudential 50 percent of the Schnitzer-PMS stock. After

Prudential declined Schnitzer's offer and prior to September

1976, Schnitzer and Kanter began discussing Kanter's purchasing

50 percent of Schnitzer-PMS. Kanter indicated that he could

obtain additional business for Schnitzer-PMS through his business

contacts, including his contacts with the Pritzkers. Before

agreeing to the sale of the stock, Schnitzer confirmed with

Ballard that Kanter could bring in business for Schnitzer-PMS.

Kanter and Schnitzer agreed that Schnitzer-PMS would be

recapitalized to provide for preferred stock to be issued to

Century. The preferred stock was entitled to a preferred

dividend equal to the amount of Century’s bank loan outstanding

on its original purchase of Fletcher Emerson. Century would

receive the preferred stock and 52.5 percent of the common stock,

and Kanter's client (IRA) would purchase 47.5-percent (51.3

shares) of the common stock for $150,000. Although closing was

originally set for October 1976, because of difficulties in
 - 245 -

finalizing the agreement, closing did not take place until

January 1978. IRA paid $50,000 at closing and issued a

promissory note for the $100,000 balance.

Schnitzer's primary objective in selling the 47.5-percent

Schnitzer-PMS interest to IRA was to acquire business from the

Pritzkers and/or Hyatt which he felt could be obtained through

Kanter's influence. By early 1978, although Schnitzer-PMS'

business, in particular its business with Prudential, had greatly

increased, it had not received any business from Hyatt. When

such business was not forthcoming, Schnitzer decided that IRA

should sell back the Schnitzer-PMS stock. Kanter offered to

either sell IRA's stock in Schnitzer-PMS to Century or purchase

from Century Development Corp. its stock in Schnitzer-PMS for

$3.1 million. In November 1979, Century repurchased the 47.5

percent owned by IRA in July 1979 for $3.1 million, payable over

a 10-year period with interest. At the time of the repurchase,

approximately $700,000 remained outstanding on the loan for the

original purchase of Fletcher Emerson.

The payments for the repurchase of the Schnitzer-PMS stock

were accumulated in IRA until the formation of Carlco, TMT, and

BWK, Inc. In 1984, IRA transferred the funds to the three new

corporations in a 45-45-10 ratio, effectively transferring 45

percent to Lisle, 45 percent to Ballard, and 10 percent to
 - 246 -

Kanter. After 1984, IRA continued to distribute the installment

payments to Carlco, TMT, and BWK, Inc. in the 45-45-10 ratio.

Respondent asserts that Schnitzer used the sale and

repurchase of the stock as a means of paying a kickback to

Ballard and Lisle for their influence in obtaining business with

Prudential. It is argued that the kickback is evidenced by a

bargain sale price and an excessive repurchase price.

Petitioners argue that the purchase price was not a bargain

purchase because at the time of the purchase, Schnitzer-PMS had

assets with net book value of approximately $200,000 and 47.5

percent of that amount would be $95,000.

We do not think, however, that net book value of the

corporation’s assets is an appropriate measure of the value of a

service corporation. We note that when the stock was repurchased

in 1979 for $3.1 million, the corporation had net assets of

$255,581. Additionally, Schnitzer's purchase price of $1.3

million for the Fletcher Emerson stock was based on five times

the pretax income of approximately $250,000. Schnitzer-PMS' 1977

pretax income was $451,347. Five times Schnitzer-PMS' 1977

pretax income of $451,347 is approximately $2.2 million.

Allowing for the value of the preferred stock liquidation

dividend preferences equal to the $1.1 million debt outstanding

on Century’s original purchase of Fletcher Emerson, the value of

Schnitzer-PMS common stock at the time IRA acquired the stock was
 - 247 -

approximately $1.1 million. IRA acquired 47.5 percent of the

common stock with a value of at least $522,500 for $150,000.45

Furthermore, IRA paid $50,000 at closing and issued a promissory

note for the $100,000 balance. IRA did not pay the $100,000

until after Schnitzer told Kanter that he wanted to repurchase

IRA's Schnitzer-PMS stock. Clearly, IRA's purchase of the

Schnitzer-PMS stock was a bargain.

Schnitzer sold the stock to IRA at the bargain price in

exchange for Kanter's promise to use his influence with his

clients, particularly the Pritzkers, to direct business to

Schnitzer-PMS. Schott's and Weisgal's relationships to IRA, as

well as their contacts, were irrelevant. Schnitzer would have

sold the stock directly to Kanter or to any entity that Kanter

wanted to use for the transaction. Moreover, Schnitzer testified

that he would have sold the stock for less than $150,000.

With respect to the repurchase price, Schnitzer-PMS' 1978

pretax income was $832,000. When IRA sold the stock back to

Schnitzer, approximately $700,000 remained outstanding on the

loan for the original purchase of Fletcher Emerson. Based on

five times earnings, at the time of repurchase the entire

45
Under the stock agreement entered into by Century and IRA
when IRA purchase the Schnitzer-PMS stock, upon the death of the
last to die of Kanter, Weisgal, and Schott, Century had the
option to purchase IRA’s stock. The purchase price for IRA’s
stock under the agreement was an amount in excess of 8 times
Schnitzer-PMS’s average pretax income. Eight times Schnitzer-PMS
pretax income for 1977 is over $3.6 million.
 - 248 -

business was worth approximately $4.2 million ($832,000 x 5);

allowing for the liquidation and dividend preferences of the

preferred stocks the common stock had a value of roughly $3.5

million ($4.2 million - $700,000), and IRA's 51.3 shares of

common stock had a value of roughly $1.6 million ($3.1 million x

47.5 percent).46 The Court notes, however, that around the end of

1979 or early 1980, Schnitzer discussed the sale of Schnitzer-PMS

to Minneapolis Honeywell for a price between $12 million and $13

million.47 Although Honeywell decided not to purchase Schnitzer-

PMS, we think that when Schnitzer agreed to repurchase the

Schnitzer-PMS stock from IRA, he thought the stock was worth $3.1

million. Otherwise, he would have sold Century's stock to IRA.

Schnitzer's primary objective in selling the 47.5-percent

Schnitzer-PMS interest to IRA was to acquire business from Hyatt

which he felt could be obtained through Kanter's influence.

Apparently, when Schnitzer negotiated the reacquisition of the

stock, he was unaware of the assistance from Ballard or Lisle for

46
Roland Burrows, chief office and president of Schnitzer-PMS
during the years at issue, testified that the business of the
corporation grew at about 25 percent each year until about 1976.
The rate of growth slowed substantially after that time because
of the size of the corporation.
47
Under the stock agreement entered into by Century and IRA
when IRA purchased the Schnitzer-PMS stock, the purchase price
for IRA’s stock was an amount in excess of 8 times Schnitzer-
PMS’s average pretax income. Eight times Schnitzer-PMS pretax
income from 1976 to 1978 ($533,500) is more than $4.2 million.
Based on that value all of the stock in the corporation was worth
more than $8 million.
 - 249 -

additional property management business with Prudential. Thus,

although we find that Schnitzer sold the stock to IRA at a

bargain price for Kanter's influence, we cannot say that

Schnitzer intended the payments to repurchase the stock as

kickbacks to Ballard and Lisle.

The flow of the money, however, makes it clear that Kanter

agreed to share the money received from the transaction with

Ballard and Lisle in exchange for their assistance in giving more

Prudential business to Schnitzer-PMS. The increase in the

Prudential business greatly increased the pretax income and,

thus, the value of the Schnitzer-PMS stock. IRA, as with the

other transactions involving the Five, held for the benefit of

Ballard, Lisle, and Kanter the funds received from the repurchase

of its stock in Schnittzer-PMS, and distributed the funds to the

individuals through Carlco, TMT, and BWK, Inc.

5. The Eulich/Essex Arrangement

The final arrangement involved petitioners, Eulich, and

Connolly. Eulich was a real estate developer and had known

Ballard and Lisle since at least 1965. Eulich dealt with Ballard

and Lisle in connection with Prudential's financing his

development of real estate. Eulich and Kanter had also known

each other since the late 1960's or early 1970's and had had many

business dealings with each other. Eulich owned a hotel

management company called Eulich-Management. Connolly was an
 - 250 -

employee of another management company that managed Prudential's

Gateway Hotel. Connolly was employed as the in-house manager of

Prudential's Gateway Hotel. In 1981, Connolly threatened to quit

because he wanted an increase in his compensation. Prudential

began discussing giving the management contract to Connolly.

Ballard introduced Connolly to Eulich. Kanter, Eulich, and

Connolly then organized two corporations, a hotel management

company called Gateway Corp. and Essex Corp. (incorporated in

1981). Eulich provided $10,000 for the initial capitalization of

Gateway Corp. Connolly was issued all of the stock of Gateway

Corp., but granted Essex Corp. a 10-year option to purchase 80

percent of the stock.

By February 1, 1982, Gateway Corp. entered into management

contracts with Prudential to operate the Gateway Hotel and the

Midland Hotel (another hotel owned by Prudential). Gateway Corp.

was required by Prudential to provide financial reports on the

Gateway Hotel's operations. The full-time employment of

personnel to perform these and other required services would have

been uneconomical, since Gateway Corp. would be managing only one

or two hotels. Therefore, Eulich agreed that employees of

Eulich-Management would provide these services for Gateway Corp.

Eulich, Kanter, and Connolly also formed the Essex

partnership (organized effective January 1, 1982). Eulich-

Management held a 47.5-percent interest in Essex, Connolly a 5-
 - 251 -

percent interest, and Kanter's entities IRA and Holding Co. held

the remaining 47.5 percent (26.125 percent and 21.375 percent,

respectively).

The Essex partnership entered into "Representation and

Marketing" agreements with Eulich-Management and Gateway Corp.,

effective January 1, 1982. The Eulich-Management/Essex agreement

required Eulich-Management to pay to Essex 30 percent of its

management fees from its operation of the Madison Hotel and 43

percent of the fees from its operation of the Allentown Hilton.

The Gateway Corp./Essex agreement required Gateway Corp. to pay

to Essex 75 percent of Gateway Corp.'s management fees from the

operations of the Gateway Hotel and the Midland Hotel.

The Essex partners agreed that Gateway Corp. and Eulich

Management generally would pay the same amount of fees to the

Essex partnership. The partnership's specified percentage of

fees under each consulting and fee participation agreement could

be adjusted and modified if a significant change occurred with

respect to the compensation that Gateway Corp. or Eulich-

Management received under a particular hotel management contract.

Substantially all of Essex's income came from Gateway Corp. and

Eulich-Management.

From 1982 to 1988, Essex received $1,334,601 in commission

fee payments from Gateway Corp. and $1,563,412 from Eulich-

Management. In 1989, Essex received a total of $293,261 from
 - 252 -

Eulich-Management and Gateway Corp. From 1982 to 1989, Essex

distributed $788,452 to IRA, $645,028 to Holding Co., $150,899 to

Connolly, and $1,433,551 to Eulich-Management.

IRA accumulated the money paid to it by Essex until 1983.

In 1983, IRA began distributing the money to Ballard, Lisle, and

Kanter through Carlco, TMT, and BWK, Inc., in the 45-45-10 ratio.

On December 31, 1984, IRA transferred its partnership interest in

Essex to Carlco, TMT, and BWK, Inc., in the 45-45-10 ratio. IRA

did not inform the Essex partnership of the transfer and

continued to receive the payments from Essex and then transferred

the payments to Carlco, TMT, and BWK, Inc.

Essex had no real business purpose. It had no office,

equipment, or employees and did not perform any services under

the "Representation and Marketing" agreements with Eulich-

Management and Gateway Corp.

Eulich's relationship with Ballard, Lisle, and Kanter was

longstanding. Lisle's son was employed by one of Eulich's

Vantage companies. The Court is convinced that Eulich agreed

that Eulich-Management would participate in the Essex arrangement

and provide services to Gateway Corp. as payment to Kanter,

Lisle, and Ballard for their influence with respect to other

business directed to Eulich and his corporations. Eulich

testified at trial that he caused Eulich-Management to

participate in the Essex partnership because he expected that
 - 253 -

Kanter might eventually help Eulich-Management obtain management

contracts for larger hotels.

Although Connolly was an excellent hands-on hotel manager,

he had no experience with the financial or reporting aspects of

managing a hotel. He participated in the formation of Gateway

Corp. and Essex and the financial arrangement because he wanted

more money than he had been receiving from the company managing

the Gateway Hotel. His participation in this activity was solely

at the direction of Ballard, Lisle, and Kanter. Connolly was

nothing more than a pawn of Kanter, Ballard, and Lisle.

Employees of Eulich-Management performed record-keeping and

reporting services for Gateway Corp., but Eulich-Management did

not charge Gateway Corp. for these services. At least 50 percent

of the money received by the Essex partnership came from Eulich-

Management, which in turn received only 47.5 percent of the

distributions. Under the arrangement, there was no way Eulich-

Management could ever make a profit by participating in the Essex

arrangement. IRA and Holding Co., on the other hand, never

contributed any money to the Essex partnership and never provided

any services to Gateway Corp. or the Essex partnership, yet

together IRA and Holding Co. received 47.5 percent of the

distributions from Essex.

Eulich-Management received back in the form of partnership

distributions most of the payments it made to Essex. The net
 - 254 -

effect was that 75 percent of the management fees Prudential paid

to Gateway Corp. was distributed through Essex to Holding Co. and

IRA, and finally to Kanter, Ballard, and Lisle. The

"Representation and Marketing" agreements thus merely served to

disguise payments from the operation of the Gateway and Midland

hotels to Kanter, Ballard, and Lisle.

The income to IRA was offset with losses reported on its

consolidated return. The entire convoluted arrangement served to

conceal Kanter, Ballard, and Lisle's interest in the operations

of the hotels from Prudential and to avoid tax.

As with payments made by other members of the Five to IRA,

the payments were accumulated in IRA until the formation of

Carlco, TMT, and BWK Inc. The funds accumulated in IRA were

distributed in the 45-45-10 ratio to Carlco, TMT, and BWK, Inc.,

and thus, distributed to Lisle, Ballard, and Kanter. The record

does not show that the payments made to Holding Co. were

distributed to anyone other than Kanter. On the basis of the

evidence clearly established in the record, we conclude that

Kanter, Ballard, and Lisle agreed that Kanter would receive for

his services 100 percent of the Essex payments made to Holding

Co. and 10 percent of the Essex payments made to IRA and that

Ballard and Lisle each would receive for their services 45

percent of the Essex payments made to IRA.
 - 255 -

6. Conclusion

At trial, all the witnesses associated with the Five

explicitly denied that the payments described were "kickbacks" or

"payoffs" for Ballard and/or Lisle's help in steering business to

them. Those witness did confirm, however, that they entered into

these arrangements in exchange for Kanter's influence in

obtaining business. Furthermore, it is clear from the record

that Kanter, Ballard, and Lisle agreed to share and did share the

money from the Prudential transactions in a 45-45-10 split.

Although some of the Prudential payments and transactions

were finalized after Ballard and Lisle left Prudential, the

transactions began long before Ballard and Lisle left Prudential.

The payments had their genesis in transactions with which Ballard

and Lisle were both familiar and in which they were directly or

indirectly involved while they held executive positions with

Prudential. The transactions, even if occurring after Ballard

and Lisle left Prudential, were simply a continuation of what was

laid out and planned in earlier years.

Thus, we find that 70 percent of the payments from Hyatt to

KWJ Corp., all of the payments by Frey to Zeus, all of the

payments from Schaffel connected with Prudential transactions and

made to IRA, the bargain element in the sale of the Schnitzer-PMS

stock to IRA, and all of the Essex distributions to IRA are

attributable to services provided by Ballard, Lisle, and Kanter.
 - 256 -

We further find that the payments made by Frey to Holding Co.,

the payments made by Schaffel to IRA and Holding Co. from

transactions not involving Prudential, and the distributions from

Essex to Holding Co. are attributable solely to services provided

by Kanter.

B. Overview of the Law

Gross income includes all income from whatever source

derived. See sec. 61(a). The principle that income is taxed to

the person who earned it is basic to our income tax system. See

United States v. Basye, 410 U.S. 441, 450 (1973); Commissioner v.

Culbertson, 337 U.S. 733, 739-740 (1949); Lucas v. Earl, 281 U.S.

111, 115 (1930). In United States v. Basye, supra at 450, the

Supreme Court stated: "The principle of Lucas v. Earl, that he

who earns income may not avoid taxation through anticipatory

arrangements no matter how clever or subtle, has been repeatedly

invoked by this Court and stands today as a cornerstone of our

graduated income tax system". (Emphasis supplied.)

No device or arrangement, no matter how shrewdly or

cunningly contrived, can make earnings from personal services

taxable to anyone other than the real earner. This principle has

been applied to various income-splitting devices, e.g.,

anticipatory assignments of income to family members (Lucas v.

Earl, supra); family trusts (Helvering v. Clifford, 309 U.S. 331

(1940)); family partnerships (Commissioner v. Tower, 327 U.S. 280
 - 257 -

(1946); Lusthaus v. Commissioner, 327 U.S. 293 (1946);

Commissioner v. Culbertson, supra; Alexander v. Commissioner, 194

F.2d 921 (5th Cir. 1952)); and shareholder-corporation

arrangements (Gregory v. Helvering, 293 U.S. 465 (1935);

Griffiths v. Commissioner, 308 U.S. 355 (1939); Higgins v. Smith,

308 U.S. 473 (1940); Moline Properties, Inc. v. Commissioner, 319

U.S. 436 (1943); Commissioner v. Court Holding Co., 324 U.S. 331

(1945)).

If, as in these cases, the issue involves income paid to

corporations, we encounter the important policy of the law

favoring recognition of a corporation as a legal person and

economic actor. If corporations are formed for substantial

business purposes, or are actually engaged in substantial

business activities, the corporate forms must be recognized for

tax purposes. See Moline Properties, Inc. v. Commissioner,

supra. On the other hand, if the subject entities are unreal or

shams, the corporate form must be disregarded for tax purposes.

See Higgins v. Smith, supra.

A finding that a corporation is a sham allows the

Commissioner to disregard the corporation altogether for tax

purposes. See Haberman Farms, Inc. v. United States, 305 F.2d

787 (8th Cir. 1962); James Realty Co. v. United States, 280 F.2d

394 (8th Cir. 1960). A finding that a corporation is not a sham,

however, does not preclude reallocation under the assignment of
 - 258 -

income doctrine. It is still possible that a taxpayer could

assign the receipt of income earned to a viable corporation in an

attempt to avoid the tax liability for that income. This would

violate the general principle that income is taxable to the

person who earns it. See United States v. Basye, supra at

449-450; Helvering v. Horst, 311 U.S. 112, 119 (1940); Lucas v.

Earl, supra at 114-115. Additionally, section 482 authorizes the

Secretary to apportion or allocate income between organizations

controlled by the same interests if he determines that such

distribution, apportionment, or allocation is necessary in order

to prevent evasion of taxes or clearly to reflect the income of

any such organizations.

1. Sham Corporations

Respondent asserts that IRA, its subsidiaries Carlco, TMT,

and BWK, Inc., and Holding Co. were sham or dummy corporations

that should not be recognized as separate taxable entities. We

agree.

Although taxpayers have the right to mold their business

transactions in such a manner as to minimize the incidence of

taxation, United States v. Cumberland Pub. Serv. Co., 338 U.S.

451 (1950), the Government is not required to acquiesce in the

form chosen by taxpayers for doing business. If the form is

unreal and a sham, the fiction may be disregarded for purposes of

the tax statutes. See Higgins v. Smith, supra; Gregory v.
 - 259 -

Helvering, supra. The question whether a corporation is genuine

or a sham is one of fact. See Noonan v. Commissioner, 451 F.2d

992, 993 (9th Cir. 1971), Shaw Constr. Co. v. Commissioner, 323

F.2d 316, 321 (9th Cir. 1963).

In Moline Properties, Inc. v. Commissioner, supra at 438-

439, the Supreme Court established the following test for

determining whether a corporation will be recognized as a

separate taxable entity:

The doctrine of "corporate entity" fills a useful
purpose in business life. Whether the purpose be to
gain an advantage under the law of the state of
incorporation or to avoid, or to comply with the
demands of creditors or to serve the creator's personal
or undisclosed convenience so long as that purpose is
the equivalent of business activity or is followed by
the carrying on of business by the corporation, the
corporation remains a "separate taxable entity". * *
* [Fn. refs. omitted.]

Thus, if the corporations were organized for substantial business

purposes, or actually engaged in substantial business activities,

their corporate forms must be recognized for tax purposes.

To be recognized, a corporation must be organized for a

substantial "business" purpose in the ordinary meaning. See

National Investors Corp. v. Hoey, 144 F.2d 466, 468 (2d Cir.

1944). "[E]scaping taxation is not 'business' in the ordinary

meaning". Id. Thus, a corporation organized for the purpose of

avoiding tax is not organized for substantial business purposes.

It is clear from the evidence in these cases that the

multiple corporations, as well as the trusts and partnerships,
 - 260 -

organized by Kanter were not organized for any substantial

business purpose but were organized primarily to obtain tax

benefits.

Kanter routinely created "shelf" corporations that remained

inactive until he needed a vehicle to channel payments from his

various schemes. At trial, Kanter admitted that Carlco, TMT, and

BWK, Inc., were "shelf" corporations. Thus, any business

purposes set forth in the articles of incorporation were merely

gestures without substance.

Furthermore, Kanter routinely created various corporations,

partnerships, and trusts with similar names; for example, Cedilla

Co., Cedilla Investment Co., Investment Research Associates, Ltd.

(formerly Cedilla Co.), Cedilla Co. (formerly Arba Investments

Inc.), and Cedilla Trust; KWJ Corp. and KWJ Co. partnership;

Essex Corp. and Essex Partnership. As a result of the intended

confusion created by similar names, Kanter could substitute one

entity for another. For example, after KWJ Corp. was liquidated,

the payments from Hyatt to KWJ Corp. were simply treated as

payments to the KWJ Co. partnership. Hyatt never knew about the

change until about 1992.

Moreover, assuming IRA's predecessor Cedilla Co. (Old

Cedilla Co.) had been incorporated for the purpose of brokering
 - 261 -

real estate (a valid business purpose48), we cannot attribute the

purpose for the formation of Old Cedilla Co. to IRA. Originally,

Keating owned the common stock of Old Cedilla Co., and Schott

owned the preferred class A preferred stock.

In 1975, the same year Weaver agreed to sell KWJ Corp. to

Kanter, Keating's 1,000 shares of common stock of Old Cedilla Co.

were exchanged for 500 shares of class B preferred stock,49 and

Weisgal as trustee of the Bea Ritch trusts acquired 1,000 shares

of the common stock. Schott continued to hold the class A

preferred stock in Old Cedilla Co. to enable Old Cedilla Co. to

qualify for a corporate broker's license.

In 1978, Old Cedilla Co.'s name was changed to IRA. When

Old Cedilla Co.'s name changed, IRA acquired 1,000 shares of Arba

and changed the name of Arba to Cedilla Co (New Cedilla Co.).

IRA's end of year balance sheet indicates that IRA's 1,000 shares

of Cedilla Co. were the only shares outstanding.

In 1983, IRA made a journal entry to show that IRA redeemed

Schott's 500 shares of IRA class B preferred stock in exchange

for IRA's 1,000 shares of its Cedilla Co. stock.

Schott thought that, when Cedilla Co.'s name was changed to

IRA, she acquired another company and the name of that

48
The Court, however, is not convinced that Cedilla Co. was
organized for any purpose other than to serve as a vehicle for
Kanter's various tax avoidance schemes.
49
Keating's preferred stock was redeemed in 1977.
 - 262 -

corporation was changed to Cedilla Co. She did not know that she

had owned any of the stock of IRA after the name change. She

testified that she owned New Cedilla Co. and that she conducted

her real estate brokerage business individually as well as

through IRA and New Cedilla Co.

The name change occurred in 1978, the same year IRA

purchased the stock of Schnitzer-PMS and the payments to IRA

related to the Prudential transactions began. In 1979, when IRA

acquired the stock of KWJ Corp., Schaffel began splitting

commissions with Kanter, and Century repurchased IRA’s Schnitzer-

PMS stock. When Cedilla Co.'s name was changed to IRA, whatever

the purpose Cedilla Co. was originally formed to pursue, it is

evident that purpose went along with the name to a new Cedilla

Co.

We find that the corporations and entities were not

organized for any valid business purposes.

A corporation is not treated as carrying on a business

merely because it engages in certain corporate formalities, such

as holding corporate meetings, adopting bylaws, electing officers

and directors, issuing securities and keeping separate books.

See Aldon Homes, Inc. v. Commissioner, 33 T.C. 582, 600-601

(1959). In order to be treated as carrying on a business, in

addition to engaging in corporate formalities, the corporation

must hold itself out to unrelated third parties and engage in
 - 263 -

substantial business activities. See Skarda v. Commissioner, 250

F.2d 429, 434-435 (10th Cir. 1957), affg. 27 T.C. 137 (1956).

Further, a corporation is not treated as carrying on a business

if its activities, such as executing contracts and filing tax

returns, are merely "empty gestures" rather than substantial

transactions. Kimbrell v. Commissioner, 371 F.2d 897, 901-902

(5th Cir. 1967), affg. T.C. Memo. 1965-115.

The following factors lead us to the conclusion that IRA did

not carry on any business.

We first observe that the original Cedilla Co. paid minimal

salaries or wages in 1977 ($986) and 1978 ($5,051). After the

name change in 1979, IRA paid minimal salaries or wages only in

1981 ($9,969), and 1982 ($26,079) and paid no salaries or wages

in any other year. In fact, there is no evidence that IRA had

any employees other than bookkeepers who also performed

bookkeeping services for the multitude of other Kanter entities.

Although the original Cedilla Co. paid substantial commissions

and consulting fees from 1976 to 1979, after the name change, IRA

paid commissions only in 1981 ($115,400) and in 1985 ($4,000) and

paid consulting fees only in 1982 ($29,000).

The original Cedilla Co. paid officer's fees in 1977

($19,300) and 1978 ($15,000). After the name change, IRA did not

pay any officer's or director's fees (except the $12,500 payment

made to Ballard).
 - 264 -

Furthermore, there is no evidence that the commissions,

consulting fees, officer's fees, or director's fees were properly

characterized as such payments or paid for services provided to

the corporations. For example, petitioners assert that Ballard

was never a director of IRA and that the $12,500 payment to

Ballard was not in fact a director's fee. KWJ Corp. and KWJ Co.

partnership paid Ballard's and Lisle's children consulting fees,

yet the children never provided any services for the payments.

Additionally, there is no evidence that any of IRA's income

was attributable to Schott's real estate activity. Schott could

not remember exactly what she did for IRA. She merely signed

documents without any real knowledge of the transactions

involved. When IRA redeemed Schott's 500 shares of IRA class B

preferred stock in 1983, IRA no longer qualified to hold a

corporate broker license.

The payments of development fees from Frey and the BJF

partnership were not related to any investment IRA and Holding

Co. may have made in any of Frey's condominium conversion

projects.

We conclude that the corporations did not carry on

substantial business activity in the ordinary meaning.

Finally, even if we were able to find some modicum of

business activity, petitioners and other parties to the various

transactions did not recognize any of the corporations or
 - 265 -

entities as valid separate entities or true parties in interest

to the various transactions. Some of the individuals involved in

the transactions with Kanter had never heard of IRA, and those

that had, considered IRA to be Kanter.

Around 1992, Kanter attempted to have Hyatt send the

payments to the KWJ Co. partnership instead of to Weaver. While

Kanter provided Hyatt with documents showing that KWJ Corp. had

been sold to IRA, liquidated, and the contract rights assigned to

KWJ Co. partnership, Hyatt refused to do so without Weaver's

consent, which had not been attained at the time of trial. Hyatt

continued to send the payments to Weaver.

After Lisle began working for Travelers, although Schaffel's

agreement was purportedly with IRA, he sent payments from

Travelers deals to Holding Co. If IRA, rather than Kanter, had

been the true party in interest and had been Kanter's client, the

payments for the Travelers deals would have been paid to IRA.

A comparison of the business records of IRA, Administration

Co., Int'l Films, Holding Co., and HELO illustrates the sham

nature of the entities. Kanter completely controlled IRA,

Holding Co., Administration Co., HELO, Int'l Films, and the

various trusts. He had unrestricted power over the commingled

funds and was in a position to determine and direct the payments

from outside sources to the various entities. He routinely used

the funds for his own benefit. He routinely shifted accounts
 - 266 -

between entities with no documentation to establish a rationale

for such transfers. He created phony loans that were eventually

written off, and then he or the corporations took bad debt

deductions to offset additional income.

Similarly, Lisle, Ballard, and Kanter failed to recognize

any separate identity of Carlco, TMT, and BWK, Inc. Petitioners

assert that Lisle, Ballard, and Kanter were only the respective

managers of the assets of Carlco, TMT, and BWK, Inc., and claim

that the preferred stock issued to their family trusts had

minimal value. The record clearly shows, however, that

petitioners' control over the assets of the corporations went far

beyond that of a manager.

Petitioners used the funds for their personal benefit. From

1984 to 1986, Ballard transferred $16,599 to himself that was

recorded as a receivable on TMT's books. In 1987, Ballard

transferred the St. Francis Arkansas land owned by TMT to himself

and recorded the transfer as a sale. He did not pay for the land

but recorded a receivable of $100,000 as owed by him on TMT's

books. In 1987, TMT funds also were used to pay $20,344 to the

Fairfield Plantation Company, Ballard's S corporation. The

payment was recorded as a receivable owed by Ballard. In 1989,

Ballard distributed $10,000 to himself from TMT and increased his

receivable to $146,943. In addition, Ballard distributed

$160,000 of TMT's funds to his wife, $122,900 to the Seabright
 - 267 -

Trust, $10,080 to the Seabright Corp., all recorded as

receivables. Ballard distributed $19,000 to Ficom (Melinda

Ballard's sole proprietorship) that TMT later wrote off as a

worthless investment. Ballard and his wife referred to farms

owned by TMT as their farms.

Kanter took $400,000 out of BWK, Inc. and recorded the

distribution as a receivable. Lisle used $3,000 of Carlco's

funds to pay a receivable on the books of Administration Co. The

payment did not create a receivable on Carlco's books.

When receivables were recorded for funds taken out of the

corporations, there was no intention or expectation that the

funds would be repaid, and there was never any attempt to collect

the receivables until the IRS began auditing petitioners'

returns.

Petitioners used the corporations' partnership, KWJ Co., to

distribute money to the Ballard and Lisle children in the guise

of consulting fees. The children never performed any services

for the payments.

Petitioners maintained possession of the corporations'

assets and records. The addresses given for Carlco and TMT were

the addresses of Lisle's and Ballard's residences. When Lisle

lived in Connecticut, the records were maintained in Connecticut;

when he moved to Texas, the records and accounts were maintained

in Texas.
 - 268 -

Ballard and Lisle gave family members signatory authority

over the corporate accounts. Mary Ballard had signatory

authority over TMT’s Wells Fargo Bank account. Donna Lisle and

Lisle's brother had signatory authority over Carlco's Goldman

Sachs account. Donna Lisle had signatory authority over Carlco's

North Dallas bank account.

Petitioners assert that the only interest they had in

Carlco, TMT, and BWK, Inc., was the preferred stock issued to the

family trusts and that the stock had minimal value. The

certificates of incorporation of Carlco, TMT, and BWK, Inc.

authorized each corporation to issue 1,000 shares of 10-cent par

value common stock. Certificates of amendment, filed in December

1983, authorized the corporations to issue 11,000 shares of stock

comprised of 10,000 shares of 1-cent par value preferred stock

and 1,000 shares of 10-cent par value common stock. The amended

certificates granted each corporation's board of directors

authority to fix the preferences of the preferred shares. The

record does not contain any evidence of resolutions by the board

of directors of any of the three corporations setting preferences

or limitations on the preferred stock.

Petitioners point to the following preferences and other

characteristics printed on the back of the stock certificates to

support their assertion that the preferred stock of Carlco, TMT,

and BWK, Inc. issued to the family trusts had minimal value:
 - 269 -

1. One vote per share.

2. Dividends payable only when, if, and as declared at
a maximum rate of 10 percent per annum after 1990.
Dividends are non-cumulative.

3. Redemption by company at any time upon 10 days
notice at 105 percent.

4. Priority on liquidation equal to original purchase
price per share.

5. Shares are not convertible into common stock.

Petitioners claim that the certificates prove that the

preferred shares could not be worth more than approximately

$1,650, which could only be realized upon liquidation or upon

redemption of the shares. We disagree. First, in their briefs,

petitioners inserted "of par" into the redemption rights to read

"Redemption by company at any time upon 10 days notice at 105

percent of par." The preferred stock could instead be redeemable

for 105 percent of, e.g., the retained earnings. Similarly, with

respect to liquidation rights, "priority on liquidation equal to

original purchase price per share" is also subject to multiple

interpretations. The shares could be entitled to the original

purchase price first but also allowed to share with the common

stock in the remaining assets. Original purchase price could

include a value set for the uncompensated services of the manager

(Ballard, Lisle, and Kanter). That value could be tied to the

retained earnings of the corporations or at an annual amount.

Without a resolution by the board of directors setting forth
 - 270 -

preferences, we find the preferences reflected on the

certificates to be ambiguous. Petitioners failed to produce any

corporate resolution. We can only infer that the resolutions

contradict petitioners' assertions. Finally, the record

establishes that Kanter was not restrained by corporate

formalities including preferences, stock ownership, asset

ownership, etc.

Kanter claims that Carlco's preferred stock was issued to

Lisle's family trust to give Lisle more control and discretion

with respect to Carlco's investments. We fail to see how stock

that does not have voting control could provide such control or

discretion with respect to the assets of the corporations.

Lisle, Ballard, and Kanter, respectively, had unrestricted

control of the assets of Carlco, TMT, and BWK, Inc. We think

that fact is a strong indicator of the true owners of the assets.

On the basis of the record before us, we conclude that

Kanter personally diverted payments of compensation, including

those made by the Five for his, Ballard's, and Lisle's services

and influence, through IRA, Holding Co., and their subsidiaries.

Petitioners formed and utilized all the corporations as a way to

conceal their true income for the years at issue. The record is

clear that petitioners used all of these accounts as parts of

incorporated or unincorporated pocketbooks. The corporations
 - 271 -

whose names were on the various accounts did not earn the taxable

amounts attributed to those accounts.

A taxpayer cannot expect the Commissioner to recognize the

separate identity of an entity where the taxpayer himself so

blatantly ignores any separate existence. Nor should the courts

require the Commissioner to do so.

On the record presented to us, we find that IRA, Holding

Co., their subsidiaries, including Zeus, Zion, Carlco, TMT, and

BWK, Inc. did not carry on any business and were only the alter

egos of Kanter, Lisle, and Ballard. We find the various entities

to be pure tax avoidance vehicles. The corporations were nothing

more than a few incorporating papers of no significance except

when a tax return was due. Petitioners diverted millions of

dollars of income. The make-believe corporations were shams and

too transparent to accept for tax purposes.

2. Assignment of Income

Even if the corporations that received the payments from the

Five had been viable entities, that would not preclude

application of the assignment of income doctrine, as a taxpayer

could assign income to a corporation that conducts real and

substantial business in an attempt to avoid tax. See Haag v.

Commissioner, 88 T.C. 604, 611 (1987), affd. without published

opinion 855 F.2d 855 (8th Cir. 1988).
 - 272 -

Gross income means all income from whatever source derived,

including compensation for services, including fees, commissions,

and similar items. See sec. 61(a)(1). Compensation for services

is an item of gross income that cannot be effectively assigned to

escape the burden of taxation. See Lucas v. Earl, 281 U.S. at

114-115. This Court has upheld reallocations of income from a

validly organized and operated corporation to its

shareholder/employee under the assignment of income doctrine.

See Bagley v. Commissioner, 85 T.C. 663 (1985), affd. 806 F.2d

169 (8th Cir. 1986); Askew v. Commissioner, T.C. Memo. 1985-100,

affd. 805 F.2d 830 (8th Cir. 1986). Respondent cites DeVaughn v.

Commissioner, T.C. Memo. 1983-712, as an example of a similar

situation in which the assignment of income doctrine was applied

to tax kickback payments to an individual taxpayer who had earned

the payments but sought to redirect them to that taxpayer's

corporation.

In cases involving viable corporations, we consider all the

facts and circumstances to determine the actual earner of income.

See Schuster v. Commissioner, 800 F.2d 672 (7th Cir. 1986), affg.

84 T.C. 764 (1985); Fogarty v. Commissioner, 780 F.2d 1005 (Fed.

Cir. 1986), affg. 6 Cl. Ct. 612 (1984); Leavell v. Commissioner,

104 T.C. 140, 155 (1995). In determining the proper taxpayer, we

consider which person or entity controls the earning of the

income, such as:
 - 273 -

(1) Whether the individual rather than the corporation or

entity that received the income, in fact, controlled the earning

of the income, see Vercio v. Commissioner, 73 T.C. 1246 (1980);

(2) whether the individual performed the services as an

agent or employee of the corporation, see Rubin v. Commissioner,

51 T.C. 251 (1968);

(3) whether the corporate form and the status of the

corporation as an actual operating enterprise have been

recognized by petitioners;

(4) whether the corporate form and the status of the

corporation as an actual operating enterprise have been

recognized by the other parties to the transactions giving rise

to the income;

(5) whether the form of the transaction served an economic

purpose, see Rubin v. Commissioner, supra; and

(6) whether the corporations were formed for the purpose of

taking advantage of losses incurred by a separate trade or

business.

The record shows that Kanter was in control of negotiations

concerning the amount of commissions and that he earned those

commissions by performing the work for them. He directed members

of the Five where to make payments. The various entities were

entirely subject to Kanter's control: he set up the entities, and

he managed the entities in that Meyers, Schott, Weisgal, and
 - 274 -

Freeman were subject to his control. There is no evidence that

IRA, Holding Co., or any of the other entities earned these

funds. Petitioners handled the accounts as if they were their

own, moving funds around from location to location and using the

funds for their personal benefit. This is hardly the behavior

that petitioners would exhibit if the funds in the accounts were

subject to the control of Weisgal or the various entities.

Kanter did virtually all of the planning and implementing of

the transactions. The officers, directors, and trustees signed

documents and entered transactions as Kanter directed including

issuing and redeeming stock, liquidating corporations, purchasing

and selling stock, distributing funds, and executing contracts

and agreements. There is very little evidence that IRA or the

other entities had anything to do with these transactions other

than to be the named recipients of the checks.

Lastly, we note that payments to IRA were distributed to the

accounts of Carlco, TMT, and BWK, Inc. of which petitioners and

their family members were authorized signatories. If, as

petitioners contend, the funds of the corporations did not belong

to them, they would have been misappropriating the funds through

phony loans. Therefore, we conclude that petitioners were simply

using the corporations to receive the funds they had earned.

Regardless of where the funds actually went, they were earned
 - 275 -

primarily through the efforts of petitioners via their contacts

with Prudential, Travelers, and the Pritzker family.

In Rubin v. Commissioner, supra, we found that the income

was properly taxable to the individual who performed the services

for which payment was made where the individual was not

contractually bound to (and in fact did not) render services

exclusively to a personal service corporation. In these cases,

petitioners were not contractually bound to, nor did they render

services for, the corporations.

Ballard, Lisle, and Kanter were not employees of any of the

corporations or entities involved in the transactions at issue.

Ballard and Lisle were full-time employees of Prudential,

Travelers, or Goldman-Sachs. Kanter was a self-employed

attorney.

Kanter was not an agent of the corporations. In fact, there

is evidence that Kanter in some instances held himself out to

members of the Five (in particular Schaffel) as Ballard's and

Lisle's agent, referring to them as his "associates". Ballard

and Lisle did not claim that they were agents of IRA or any other

entity (except to justify the payment Ballard received as a

director's fee from IRA while denying he was ever a director).

We have previously discussed the failure of petitioners and

other parties to the transactions to recognize the separate

existence of the corporations. None of the Five recognized any
 - 276 -

of the corporate entities as controlling petitioners' performance

of services. Even though the payments were made to various

corporations, it is clear that the other parties to the

transactions viewed IRA, Holding Co., their subsidiaries, and

Kanter as one and the same. Although the various agreements at

issue were between members of the Five and IRA, Holding Co., or

one of their subsidiaries, the record shows that there was

virtually no involvement in these arrangements by those

corporations; rather, they were agreements with the corporations

in name only.

Additionally, assuming IRA was not a sham corporation, the

purchase of the KWJ Corp. stock was merely a device to hide the

stream of income and accumulate the funds. The transaction

itself was a sham. Similarly with the purchase of the Schnitzer-

PMS stock, Schnitzer would have sold the stock directly to

Kanter. He sold it at a bargain price for Kanter's services, not

for any services from IRA, Weisgal, or Schott. It is also clear

from the flow of the installment payments on Schnitzer's

repurchase of the stock that IRA either held the stock merely as

a nominee for Kanter, Ballard, and Lisle, or agreed to pay the

money it received from the Schnitzer-PMS transaction to Ballard,

Lisle, and Kanter in exchange for their assistance in giving more

Prudential business to Schnitzer-PMS. The increase in the

Prudential business greatly increased the pretax income and,
 - 277 -

thus, the value of the Schnitzer-PMS stock. Hence the gain was

attributable to their services. IRA held the profits for the

benefit of Ballard, Lisle, and Kanter until it distributed the

funds to them through Carlco, TMT, and BWK, Inc. The record is

replete with examples of interests that were owned initially by

Kanter or an entity and then later declared to have been held by

Kanter or the entity as "nominee" for someone else. Thus, we

hold that the gain on the sale of the stock is properly taxable

to Kanter, Ballard, and Lisle.

The use of numerous corporations was to facilitate the

concealment of the payments, and such use was further motivated

by the tax benefits to be derived therefrom and for no sound

business purpose.

We conclude that the transactions at issue are classic

situations for the application of the assignment of income

doctrine articulated in Lucas v. Earl, 281 U.S. 111, 115 (1930),

and its progeny. The amounts received by the corporations were

for services rendered by petitioners to the Five and should be

includable in their income under section 61. See United States

v. Basye, 410 U.S. 441, 450 (1973).

3. Section 482

Finally, even if the corporations had been viable entities,

we do not think respondent's reallocation under section 482 was

unreasonable, arbitrary, or capricious.
 - 278 -

Section 482 authorizes the Secretary to apportion or

allocate income between organizations controlled by the same

interests if he determines that such distribution, apportionment,

or allocation is necessary in order to prevent evasion of taxes

or clearly to reflect the income of any such organizations. The

relevant regulation explains that the purpose of section 482 is

to place a controlled taxpayer on a tax parity with an

uncontrolled taxpayer, and to ensure that controlling entities

conduct their subsidiaries' transactions in such a way as to

reflect the "true taxable income" of each controlled taxpayer.

Sec. 1.482-1A(b)(1), Income Tax Regs.50

50
Sec. 1.482-1A(b)(1), Income Tax Regs provides:

The purpose of section 482 is to place a controlled taxpayer
on a tax parity with an uncontrolled taxpayer, by
determining, according to the standard of an uncontrolled
taxpayer, the true taxable income from the property and
business of a controlled taxpayer. The interests
controlling a group of controlled taxpayers are assumed to
have complete power to cause each controlled taxpayer so to
conduct its affairs that its transactions and accounting
records truly reflect the taxable income from the property
and business of each of the controlled taxpayers. If,
however, this has not been done, and the taxable incomes are
thereby understated, the district director shall intervene,
and, by making such distributions, apportionments, or
allocations as he may deem necessary of gross income,
deductions, credits, or allowances, or of any item or
element affecting taxable income, between or among the
controlled taxpayers constituting the group, shall determine
the true taxable income of each controlled taxpayer. The
standard to be applied in every case is that of an
uncontrolled taxpayer dealing at arm's length with another
uncontrolled taxpayer.
 - 279 -

In order to justify a reallocation under section 482, the

Commissioner must find (1) that there are two or more trades,

businesses, or organizations, (2) that such enterprises are owned

or controlled by the same interests, and (3) that the

reallocation is necessary to allocate income among the two or

more enterprises in order to prevent evasion of taxes or to

properly reflect each enterprise's income. See B. Forman Co. v.

Commissioner, 453 F.2d 1144, 1152 (2d Cir. 1972), affg. in part,

revg. in part 54 T.C. 912 (1970).

Section 482 was intended to apply and has been applied to

cases where the profits of one business have been offset against

the losses of another to reduce or escape tax liability. See Ach

v. Commissioner, 42 T.C. 114 (1964), affd. 358 F.2d 342 (6th Cir.

1966).

In these cases, there was shifting of profits from one

business to another (from petitioners to the various Kanter

entities); thus the primary evil that section 482 was designed to

prohibit is present. We hold that respondent's reallocation

under section 482 was not unreasonable.

4. Conclusion

We have found that 70 percent of the payments from Hyatt to

KWJ Corp., all of the payments by Frey to Zeus, all of the

payments from Schaffel to IRA, the bargain element in the sale of

the Schnitzer-PMS stock to IRA, and all of the Essex
 - 280 -

distributions to IRA are attributable to services provided by

Ballard, Lisle, and Kanter. We further have found that the gain

on the sale of the Schnitzer-PMS stock was properly taxable to

Ballard, Lisle, and Kanter. Additionally, the interest income

earned on the payments is also properly taxable to Ballard,

Lisle, and Kanter. Finally, we have found that the payments by

Frey to Zion, the payments by Schaffel to Holding Co, and the

distributions from Essex to Holding Co. are attributable to

services provided by Kanter.

In addition, we have found that the corporations were shams,

and, even if the corporations had been viable entities,

petitioners were the true earners of the income, and respondent's

allocation under section 482 was not unreasonable, arbitrary, or

capricious.

With respect to 70 percent of the payments from Hyatt to KWJ

Corp., all of the payments by Frey to Zeus, all of the payments

from Schaffel to IRA, the bargain element in the sale of the

Schnitzer-PMS stock to IRA, as well as the gain and interest on

the repurchase of the stock, and all of the Essex distributions

to IRA, we think the 45-45-10 split is clearly evident. Thus, we

hold that the payments, bargain element, gain, and interest are

taxable 45 percent to each of Ballard and Lisle and 10 percent to

Kanter.
 - 281 -

IRA acquired 47.5 percent of the common stock of Schnitzer-

PMS Corp. with a value of roughly $522,500 for $150,000. We hold

that the bargain element is $372,500 ($522,500 - $150,000) and

the gain on the sale is $2,577,500 ($3.1 million - $522,500).

The gross profit ratio is 83.15 percent ($2,577,500 divided by

$3.1 million).

IRA received the following payments of principal and

interest on the installment sale of the Schnitzer-PMS Corp.

stock:

Year Payment Principal Interest
1979 $150,000 $150,000 --
1980 533,425 211,468 $321,957
1981 534,696 309,308 225,388
1982 361,692 172,441 189,251
1983 361,692 186,655 175,037
1984 361,692 202,042 159,650
1985 361,692 218,696 142,996
1986 361,692 236,724 124,968
1987 361,692 256,217 105,475
1988 361,692 277,360 84,332
1989 840,423 822,841 17,582
Total 4,590,388 3,043,752 1,546,636

The gain on the sale is computed as follows:

Year Principal Profit Ratio Gain
1979 $150,000 .8315 $124,725
1980 211,468 .8315 175,836
1981 309,308 .8315 257,190
1982 172,441 .8315 143,385
1983 186,655 .8315 155,204
1984 202,042 .8315 167,998
1985 218,696 .8315 181,846
1986 236,724 .8315 196,836
1987 256,217 .8315 213,044
1988 277,360 .8315 230,625
Total 1,846,689
 - 282 -

In 1989, IRA accepted $822,841 as the final principal

payment, reducing the selling price to the total principal

payments of $3,043,752. For purposes of computing the 1989 gain,

adjusted gross profit on the sale is reduced to $2,521,252

($3,043,752 - $522,500). Thus, the gain recognized in 1989 is

$674,563 (the adjusted gross profit $2,521,252 less the

$1,846,689 gain recognizable in prior years).

The payments related to these transactions paid by the Five

to IRA and its subsidiaries during the years 1978 through 1989

were as follows:
 - 283 -
Schnitzer-PMS
Year Hyatt Schaffel Frey Essex Bargain Gain Interest Total

1977 $38,394 -- -- -- -- -- -- $38,394
1978 42,517 -- -- -- $372,500 -- -- 415,017
1979 119,719 $100,000 -- -- -- $124,725 -- 344,444
1980 -- 244,920 $127,372 -- -- 175,836 $321,957 870,085
1981 90,070 361,525 105,764 -- -- 257,190 225,388 1,039,937
1982 172,702 447,450 538,781 $86,212 -- 143,385 189,251 1,577,781
1983 172,090 30,981 110,125 78,375 -- 155,204 175,037 721,812
1984 186,092 -- 103,500 133,238 -- 167,998 159,650 750,478
1985 206,790 -- 128,763 120,175 -- 181,846 142,996 780,570
1986 231,263 -- -- 80,465 -- 196,836 124,968 633,532
1987 229,449 -- -- 120,698 -- 213,044 105,475 668,666
1988 197,348 -- -- 117,562 -- 230,625 84,332 629,867
1989 52,777 -- -- 51,727 -- 674,563 17,582 796,649
 - 284 -

The payments related to the Prudential transactions are

allocable to Ballard, Lisle, and Kanter in the following amounts

for each of the years 1978 through 1989:

Year Total Ballard (45%) Lisle (45%) Kanter (10%)
1978 $38,394 $17,277 $17,277 $3,839
1979 415,017 186,758 186,758 41,502
1980 870,085 391,538 391,538 87,009
1981 1,039,937 467,972 467,972 103,994
1982 1,577,781 710,001 710,001 157,778
1983 721,812 324,815 324,815 72,181
1984 750,478 337,715 337,715 75,048
1985 780,570 351,257 351,257 78,057
1986 633,532 285,089 285,089 63,353
1987 668,666 300,900 300,900 66,867
1988 629,867 283,440 283,440 62,987
1989 796,649 358,492 358,492 79,665

With regard to the $213,750 paid by Schaffel to IRA in 1983

related to a Travelers' financing transaction, as well as all

payments by the Five to Holding Co, the record does not show that

any of these payments were ever distributed to Lisle. We hold

that Kanter realized all of the income.

Schaffel, Frey, and Essex made the following payments to

IRA and Holding Co. during the years 1981 through 1989 that are

taxable to Kanter, as follows:

Year Schaffel Frey Essex Total
1981 -- $80,616 -- $80,616
1982 -- -- $70,538 70,538
1983 $213,750 16,200 64,125 294,075
1984 600,000 113,827 109,013 822,840
1985 1,160,000 256,557 98,325 1,514,882
1986 1,003,500 -- 65,835 1,069,335
1987 -- 33,570 98,752 132,322
1988 -- -- 96,188 96,188
1989 -- -- 42,332 42,332
 - 285 -

We hold that Ballard's omitted income from the Five for the

years before the Court is as follows:

Year Omitted Income
1978 $17,277
1979 186,758
1980 391,538
1981 467,972
1982 710,001
1984 337,715
1987 300,900
1988 283,440
1989 358,492

We hold that Lisle's omitted income from the Five for the

years before the Court is follows:

Year Omitted Income
1984 $337,715
1987 300,900
1988 283,440
1989 358,492

We hold that Kanter's omitted income from the Five for each

of the years before the Court is as follows:

Year Prudential Other Omitted Income
1978 $3,839 -- $3,839
1979 41,502 -- 41,502
1980 87,009 -- 87,009
1981 103,994 $80,616 184,610
1982 157,778 70,538 228,316
1983 72,181 294,075 366,256
1984 75,048 822,840 897,888
1986 63,353 1,069,335 1,132,688
1987 66,867 132,322 199,189
1988 62,987 96,188 159,175
1989 79,665 42,332 121,997
 - 286 -

III. Fraud Additions to Tax and Penalties

A. Positions of the Parties

None of the notices of deficiency issued to Ballard, Lisle,

and Kanter determined fraud. At some point in time, respondent

saw the need to amend the answers in these cases to assert that

petitioners were liable for the fraud additions to tax and

penalties and to increase the deficiencies in tax over those

determined in the notices of deficiency. The parties and the

Court agreed that the amendments to answers would not be filed in

each of these cases until the trial commenced on June 13, 1994.

Similarly, it was agreed that replies would be filed at that

time. Kanter filed a motion to strike portions of respondent's

amendments to answer that alleged increases in deficiencies and

fraud with respect to transactions unrelated to payments from the

Five.

The Court granted Kanter's motion as follows:

ORDERED that petitioners' motion to strike is
granted to the extent of all adjustments in
respondent's Amendment to Answer for an increased
deficiency in tax and additions to tax as to
transactions or events which are not related to or
constitute part of the transactions which have been
commonly referred to and identified by the parties as
the "Prudential Issues" and/or "the Five" and,
accordingly, such adjustments and the allegations of
such adjustments are hereby stricken from the record of
this case and will be excluded from consideration by
the Court.

Respondent filed a motion for reconsideration. After a

hearing on respondent's motion for reconsideration was held on
 - 287 -

July 25, 1994, that motion was denied. Ballard and Lisle also

filed, and the Court granted, motions to strike portions of

respondent's amendments to answer that asserted increases in

deficiencies and fraud with respect to transactions unrelated to

payments from the Five in their cases. Thus, the issue to be

decided is whether Kanter, Ballard, and Lisle are liable for the

additions to tax and penalties for fraud related to income from

transactions with the Five.

Respondent contends that Kanter, Ballard, and Lisle are

liable for the additions to tax and penalties for fraud for the

years at issue because they received the income from kickback

payments involved in a complex scheme intended to conceal,

mislead, or otherwise prevent the collection of taxes.

To the contrary, petitioners contend that they did not

receive such income and that respondent has failed to prove by

clear and convincing evidence that they are liable for the

asserted fraud additions to tax and penalties.

B. Applicable Statutory Provisions

For taxable years 1978 through 1981, section 6653(b)

provides for an addition to tax in an amount equal to 50 percent

of the underpayment of tax if any part of the underpayment is due

to fraud.

For taxable years 1982 through 1985, section 6653(b)(1)

provides for an addition to tax in an amount equal to 50 percent
 - 288 -

of the underpayment of tax if any part of the underpayment is

attributable to fraud. Section 6653(b)(2) provides for an

addition to tax (in addition to the addition under section

6653(b)(1)) in an amount equal to 50 percent of the interest

payable under section 6601 with respect to the portion of the

underpayment that is attributable to fraud. For purposes of

section 6653(b)(2), interest is computed for the period beginning

on the last day prescribed for payment of the underpayment

(without regard to extensions) and ending on the earlier of the

date of assessment or payment of the tax (the statutory period).

For taxable years 1986 and 1987, section 6653(b)(1)(A)

provides for an addition to tax in an amount equal to 75 percent

of the portion of the underpayment that is attributable to fraud.

Section 6653(b)(1)(B) provides for an addition to tax (in

addition to the addition under section 6653(b)(1)(A)) in an

amount equal to 50 percent of the interest payable under section

6601 for the statutory period with respect to the portion of the

underpayment that is attributable to fraud.

For taxable year 1988, section 6653(b)(1) provides for an

addition to tax in an amount equal to 75 percent of the portion

of the underpayment that is attributable to fraud. Section

6653(b)(2) provides that, if the Secretary (Commissioner)

establishes that any portion of the underpayment is attributable

to fraud, the entire underpayment is treated as attributable to
 - 289 -

fraud, except for any portion that the taxpayer establishes is

not attributable to fraud.

For taxable year 1989, section 6663(a) provides for the

imposition of a fraud penalty in an amount equal to 75 percent of

the portion of the underpayment that is attributable to fraud.

Section 6663(b) provides further that, if the Secretary

(Commissioner) establishes that any portion of the underpayment

is attributable to fraud, the entire underpayment is treated as

attributable to fraud, except for any portion that the taxpayer

establishes is not attributable to fraud.

C. General Legal Principles Relating to Civil Fraud

The Commissioner bears the burden of proof with respect to

the additions to tax and penalties for fraud, and that burden

must be carried by clear and convincing evidence. See sec.

7454(a); Rule 142(b); Rowlee v. Commissioner, 80 T.C. 1111, 1123

(1983).

Respondent must establish each element of fraud by clear and

convincing evidence in each of the years at issue. See sec.

7454(a); Rule 142(b); Smith v. Commissioner, 926 F.2d 1470, 1475

(6th Cir. 1991), affg. T.C. Memo. 1989-171; Traficant v.

Commissioner, 884 F.2d 258, 263 (6th Cir. 1989), affg. 89 T.C.

501 (1987). In view of our order granting petitioners' motions

to strike portions of respondent's amendments to answers,

respondent must prove by clear and convincing evidence for each
 - 290 -

of the years in issue (1) the existence of an underpayment of tax

each year attributable to transactions related to the Five, and

(2) that the underpayment of that tax is due to fraud.

However, if respondent establishes that there are

underpayments of tax from transactions related to the Five that

are attributable to fraud, the amount of the addition under

section 6653(b) for 1978 through 1981 and under section

6653(b)(1) for 1982 through 1985 is equal to 50 percent of the

entire underpayment of tax, including any portion of the

underpayment not related to transactions related to the Five.

Additionally, if respondent satisfies his burden for 1988 and

1989, the amount of the addition or penalty is equal to 75

percent of the entire underpayment, unless petitioners establish

that any portion of an underpayment (resulting from the other

issues decided in these cases) is not attributable to fraud.

D. Underpayments of Tax

Respondent must first prove by clear and convincing evidence

that Ballard, Lisle, and Kanter each underpaid their taxes for

each of the years at issue on income attributable to transactions

related to the Five.

Section 61(a) defines gross income to include "all income

from whatever source derived". In addition, the Supreme Court

has determined that gross income includes all "'accessions to

wealth, clearly realized, and over which the taxpayers have
 - 291 -

complete dominion'", including illegal earnings. James v. United

States, 366 U.S. 213, 219 (1961) (quoting Commissioner v.

Glenshaw Glass Co., 348 U.S. 426, 431 (1955)); accord Rutkin v.

United States, 343 U.S. 130, 137-138 (1952); Ianniello v.

Commissioner, 98 T.C. 165, 173 (1992).

We have held that the payments made by the Five to IRA

related to the Prudential transactions are taxable 45 percent

each to Ballard and Lisle and 10 percent to Kanter and the

remaining payments made to IRA and Holding Co. are taxable 100

percent to Kanter. Our holding is supported by clear and

convincing evidence in the record.

Kanter entered into arrangements pursuant to which he would

use his business and professional contacts, including his

relationship with Ballard and Lisle, to assist members of the

Five in obtaining business opportunities or in raising capital

for business ventures. In exchange for his services, Kanter

received or shared in certain fees. Kanter established a complex

organization of corporations, partnerships, and trusts to

receive, distribute, disguise, and launder the payments from

these arrangements. The payments were made to entities

controlled by Kanter and then distributed through various means

to Ballard, Lisle, and Kanter, their family members, or to

entities established for the benefit of their families.
 - 292 -

Eulich, Frey, Schnitzer, and Schaffel (members of the Five

who were involved in the transactions and who testified as

witnesses in these cases) each confirmed that they entered into

the arrangements in exchange for Kanter's using his business

connections and influence to direct business to them. There is

no doubt that the payments were made for Kanter's services and,

therefore, are income to him. The record clearly shows that out

of the payments made to IRA, Kanter agreed to pay (and did pay)

to each of Ballard and Lisle 45 percent of the payments related

to the Prudential transactions, and that he did not share any of

the payments unrelated to the Prudential transactions with

Ballard and Lisle or anyone else.

Furthermore, the record establishes beyond any doubt that

Ballard and Lisle received the benefit of the payments related to

the Prudential transactions. Some of those payments were

distributed to them directly or indirectly through their family

members and their family trusts. Some of the payments were

distributed to Ballard and Lisle through various Kanter-created

"sham" entities and were recorded as loan receivables. Others

were payments characterized as consulting fees made to their

adult children by KWJ Corp. and KWJ Co. partnership.

Kanter entities made the following "loans" to Ballard, his

family members, and entities established for the benefit of

Ballard's family members:
 - 293 -

Ballard Loans

Lender Year Distributee Amount

Int'l Films 1974 CMB Cinema Trust $10,000
Int'l Films 1975 CMB Cinema Trust 21,500
Int'l Films 1975 CMB Cinema Trust II 12,500
Int'l Films 1976 CMB Cinema Trust 8,200
Int'l Films 1976 CMB Cinema Trust 19,000
Int'l Films 1976 CMB Cinema Trust II 1,100
Int'l Films 1977 CMB Cinema Trust 2,200
Int'l Films 1977 CMB Cinema Trust II 3,400
Int'l Films 1978 CMB Cinema Trust 3,000
Int'l Films 1978 Ballard 9,500
Int'l Films 1979 Ballard 8,784
HELO 1980 Summit Trust 85,000
HELO 1981 Summit Trust 20,700
Int'l Films 1981 CMB Cinema Trust 4,000
IRA 1982 Ballard 160,400
IRA 1983 Ballard 500
Administration Co. 1983 Seabright Trust 11,300
Administration Co. 1984 Ballard 10,000
Administration Co. 1984 Seabright Corp. 25,840
TMT 1985 Mary Ballard 160,000
Administration Co. 1988 Seabright Corp. 5,000

Kanter entities made the following "loans" to Lisle, his

family members, and entities established for the benefit of

Lisle's family members:
 - 294 -

Lisle Loans

Lender Year Distributee Amount

Int'l Films 1974 RWL Cinema Trust $15,000
Int'l Films 1975 RWL Cinema Trust II 20,000
Int'l Films 1975 Lisle 10,000
Int'l Films 1976 RWL Cinema Trust 5,000
Int'l Films 1976 RWL Cinema Trust II 18,000
Int'l Films 1977 RWL Cinema Trust II 5,000
Int'l Films 1978 Lisle 9,500
Int'l Films 1978 RWL Cinema Trust II 3,750
Int'l Films 1978 RWL Cinema Trust II 4,469
Int'l Films 1979 Lisle 8,784
Int'l Films 1979 RWL Cinema Trust II 3,000
Int'l Films 1980 RWL Cinema Trust II 250
Int'l Films 1981 RWL Cinema Trust II 2,750
Int'l Films 1982 RWL Cinema Trust II 2,320
Int'l Films 1983 RWL Cinema Trust II 3,000
HELO 1983 Basking Ridge Trust 95,000
IRA/Int'l Films 1983 Lisle 3,000
Int'l Films 1984 RWL Cinema Trust II 3,000
Administration Co. 1985 RWL Cinema Trust II 3,000
Int'l Films 1986 RWL Cinema Trust II 3,000
Administration Co. 1987 RWL Cinema Trust II 2,463
IRA 1988 RWL Cinema Trust II 6,000
BWK 1989 RWL Cinema Trust II 3,000
BWK 1990 RWL Cinema Trust II 2,969

Generally, borrowed funds are not included in a taxpayer's

gross income "because the taxpayer's obligation to repay the

funds offsets any increase in the taxpayer's assets". United

States v. Centennial Sav. Bank FSB, 499 U.S. 573, 582 (1991);

accord Moore v. United States, 412 F.2d 974, 978 (5th Cir. 1969);

United States v. Rochelle, 384 F.2d 748, 751 (5th Cir. 1967).

The hallmarks of a loan are: (1) Consensual recognition between

the borrower and the lender of the existence of the loan, i.e.,

the obligation to repay; and (2) bona fide intent on the part of
 - 295 -

the borrower to repay the funds advanced. See Collins v.

Commissioner, 3 F.3d 625, 631 (2d Cir. 1993), affg. T.C. Memo.

1992-478.

There was no loan agreement between the various Kanter

entities and Ballard or Lisle. There was never any attempt to

collect on the receivables until after the IRS began questioning

the bona fides of the loans. By that time the loans had already

been written off as worthless. Even then Ballard and Lisle

denied that they had any obligation to repay. There is no doubt

that the distribution payments to Ballard and Lisle were not

loans.

Similarly, there is no doubt that the payments made by KWJ

Corp. and the KWJ partnership to Ballard and Lisle's adult

children were not for services rendered by the children.

From 1982, KWJ Corp. and the KWJ Co. partnership paid the

Lisle and Ballard children the following amounts as consulting

fees:

Lisle Children Ballard Children
Year Thomas Lisle Amy Albrecht Melinda Ballard Karen Hart
1982 $7,000 $7,000 $7,000 --
1983 12,000 12,000 12,000 --
1984 12,000 12,000 12,000 $2,000
1985 12,000 11,000 12,000 12,000
1986 12,000 13,000 12,000 12,000
1987 12,000 12,000 12,000 12,000
1988 12,000 12,000 12,000 12,000

During 1989, KWJ Co. paid the Lisle and the Ballard children

$36,000. Of the $36,000 paid to the children in 1989, Lisle's
 - 296 -

children received at least $18,000 and Ballard's children

received at least $12,000.

Petitioners claim that Thomas Lisle and Melinda Ballard were

paid the consulting fees for various services they provided to

KWJ Corp. or KWJ Co. (KWJ). During the timeframe that Thomas

Lisle was receiving $1,000 a month, he was employed elsewhere

full time. During part of this time, Thomas Lisle was employed

with the Vantage Company (Eulich's company).

Melinda Ballard received $1,000 a month from KWJ from 1983

through parts of 1989. She did not know the nature of KWJ's

business. Neither Thomas Lisle nor Melinda Ballard ever met or

spoke to Freeman.

Karen Ballard Hart (Hart) also received $1,000 a month.

During the time that Hart was receiving $1,000 a month from KWJ,

she was employed elsewhere.

Hart testified that the "service" she performed was to

attend Urban Land Institute and Hotel Industry meetings. After

she attended these meetings, she would sometimes tell Kanter what

she had heard at the meetings, and sometimes she would not tell

him what she had heard. Half of the time, Kanter was at the same

meetings she attended. Hart described her role as "more of a

general hotel industry trend thing" that she would tell Kanter

about whenever she was asked. She did not know that she

supposedly worked for KWJ. The $1,000 a month that Hart received
 - 297 -

was paid to her by checks from Administration Co., and she

testified that she worked for Administration Co.

Amy Albrecht (Albrecht) described her role as looking at

"deals". Albrecht's testimony that she submitted on the average

anywhere from 20 to 40 deals a year to Freeman greatly exceeds

the 5 or 6 deals a year she had previously claimed during an

interview with IRS agents. The $1,000 a month that Albrecht

received did not depend on what she did or how many "deals" she

looked at. She received $1,000 a month even if she did nothing.

The checks issued to Albrecht were from either KWJ or

Administration Co. During the time that Albrecht was receiving

$1,000 a month from KWJ or Administration Co., she was employed

by the Vantage company.

The testimony of Thomas Lisle, Melinda Ballard, Hart, and

Albrecht is not credible. They performed no services for KWJ.

The payments to them were from funds Ballard and Lisle earned

from the Prudential transactions.

The record clearly shows that Kanter, Ballard, and Lisle

agreed to share the payments made by the Five related to the

Prudential transactions that were paid to IRA, Zeus, and KWJ

Corp. in the ratio of 45 percent each to Ballard and Lisle and 10

percent to Kanter. Most of the funds were accumulated in IRA or

a subsidiary until after Ballard and Lisle left Prudential. It

was then that 45 percent of the accumulated funds were
 - 298 -

distributed to each of Lisle and Ballard, respectively, through

Carlco and TMT, and 10 percent to Kanter through BWK, Inc.

Respondent has established by clear and convincing evidence

that Ballard failed to report income from the Five in the

following amounts for each of the years at issue:

Year Omitted Income
1978 $17,277
1979 186,758
1980 391,538
1981 467,972
1982 710,001
1984 337,715
1987 300,900
1988 283,440
1989 358,492

Respondent has established by clear and convincing evidence

that Lisle failed to report income from the Five in the following

amounts for each of the years at issue:

Year Omitted Income
1984 337,715
1987 300,900
1988 283,440
1989 358,492

Respondent has established by clear and convincing evidence

that Kanter omitted income from the Five in the following amounts

for each year at issue:
 - 299 -

Year Prudential Other Omitted Income
1978 $3,839 -- $3,839
1979 41,502 -- 41,502
1980 87,009 -- 87,009
1981 103,994 $80,616 184,610
1982 157,778 70,538 228,316
1983 72,181 294,075 366,256
1984 75,048 822,840 897,888
1986 63,353 1,069,335 1,132,688
1987 66,867 132,322 199,189
1988 62,987 96,188 159,175
1989 79,665 42,332 121,997

For each of the years 1979 through 1989, Kanter filed

Federal income tax returns which reported adjusted gross income

and income tax paid as follows:

Adjusted Gross Income
Year Income (Loss) Tax Paid
1978 ($44,386) $1,671
1979 (105,084) --
1980 (155,026) --
1981 (53,614) --
1982 (287,536) --
1983 (819,449) --
1984 (804,482) --
1985 (954,695) --
1986 (1,529,213) --
1987 (2,004,257) --
1988 (1,340,459) --
1989 (1,331,576) --

Kanter paid no Federal income taxes during an 11-year

period, and only minimum tax in 1978 of $1,671. However, he did

pay self-employment tax for the years 1978 ($1,434), 1979

($1,855), 1980 ($2,098), and 1983 ($3,338).

Because respondent has shown by clear and convincing

evidence that Kanter, Ballard, and Lisle omitted income on their

Federal income tax returns for each of the years at issue,
 - 300 -

respondent has clearly proven the underpayments of income tax

attributable to such omitted income for those years.

E. Intent to Evade Tax

Next, respondent must show by clear and convincing evidence

that Ballard, Lisle, and Kanter intended to evade taxes known to

be owing by conduct intended to conceal, mislead, or otherwise

prevent the collection of such taxes. See Stoltzfus v. United

States, 398 F.2d 1002, 1004 (3d Cir. 1968).

The existence of fraud is a question of fact to be resolved

upon consideration of the entire record. See Gajewski v.

Commissioner, 67 T.C. 181, 199 (1976), affd. without published

opinion 578 F.2d 1383 (8th Cir. 1978). Fraud is not presumed or

imputed; it must be established by independent evidence that

establishes a fraudulent intent on the taxpayer's part. See

Otsuki v. Commissioner, 53 T.C. 96, 106 (1969). Because direct

proof of a taxpayer's intent is rarely available, fraud may be

proved by circumstantial evidence, and reasonable inferences may

be drawn from the relevant facts. See Spies v. United States,

317 U.S. 492, 499 (1943); Stephenson v. Commissioner, 79 T.C.

995, 1006 (1982), affd. 748 F.2d 331 (6th Cir. 1984). For

example, an intent to conceal or mislead may be inferred from a

pattern of conduct, see Spies v. United States, supra at 499, or

from a taxpayer's entire course of conduct, see Stone v.

Commissioner, 56 T.C. 213, 223-224 (1971). Likewise, a pattern
 - 301 -

showing a consistent underreporting of income, when accompanied

by circumstances evidencing an intent to conceal, may justify a

strong inference of fraud. See Parks v. Commissioner, 94 T.C.

654, 664, (1990).

Additions to tax for fraud have been upheld where taxpayers

received income from illegal kickback schemes. See Tregre v.

Commissioner, T.C. Memo. 1996-243, affd. without published

opinion 129 F.3d 609 (5th Cir. 1997); DeVaughn v. Commissioner,

T.C. Memo. 1983-712; Hanhauser v. Commissioner, T.C. 1978-504.

These cases bear some factual similarities to the instant cases.

Factors Indicative of Fraudulent Intent

Courts have relied on a number of indicia of fraud in

deciding fraud cases. The existence of several indicia is

persuasive circumstantial evidence of fraud. See Solomon v.

Commissioner, 732 F.2d 1459, 1461 (6th Cir. 1984), affg. per

curiam T.C. Memo. 1982-603. A non-exclusive list of

circumstantial evidence which gives rise to a finding of

fraudulent intent includes: (1) a pattern of understating income

over an extended period of time; see Foster v. Commissioner, 391

F.2d 727, 733 (4th Cir. 1968), affg. in part, revg. in part T.C.

Memo. 1965-246); (2) implausible or inconsistent explanations of

behavior; see Bahoric v. Commissioner, 363 F.2d 151, 153 (9th

Cir. 1966); Factor v. Commissioner, 281 F.2d 100 (9th Cir. 1960),

affg. T.C. Memo. 1958-94; (3) failure to cooperate with tax
 - 302 -

authorities; see McCullough v. Commissioner, T.C. Memo. 1993-70;

(4) failure to produce records during discovery, see Scallen v.

Commissioner, 877 F.2d 1364, 1370 (8th Cir. 1989), affg. T.C.

Memo. 1987-412; (5) destruction of records, see Estate of Beck v.

Commissioner, 56 T.C. 297 (1971); (6) misleading statements or

actions, see McManus v. Commissioner, T.C. Memo. 1972-200, affd.

without published opinion 486 F.2d 1399 (4th Cir. 1973), (7)

commingling of personal assets with those of the taxpayer's

corporation in an attempt to avoid tax, see United States v.

Walton, 909 F.2d 915 (6th Cir 1990); (8) diversion of income to

third parties, see Lewis v. Commissioner, T.C. Memo. 1983-547;

(9) reporting income from property beneficially owned by the

taxpayer on the returns of family members, see Lang v.

Commissioner, T.C. Memo. 1961-134; (10) structuring of a business

and use of cash management techniques which made difficult the

tracing of income, see Scallen v. Commissioner, supra at 1370-

1371; (11) banking devices used to conceal earnings, see Maddas

v. Commissioner, 114 F.2d 548 (3d Cir. 1940), affg. 40 B.T.A. 572

(1939); (12) concealing income under the names of other persons

who reported such income, see Hecht v. Commissioner, 16 T.C. 981

(1951); and (13) omission of income from the taxpayer's property,

title to which was held in names of others who reported the

income therefrom, see Furnish v. Commissioner, 262 F.2d 727 (9th

Cir. 1958). In addition, the taxpayer's educational background
 - 303 -

and experience are relevant. See Scallen v. Commissioner, supra

at 1371; United States v. Stein, 437 F.2d 775 (7th Cir. 1971).

1. Lisle's Fraud

Respondent has proven by clear and convincing evidence that

Lisle underpaid his taxes for each of the years at issue

attributable to omitted income from transactions related to the

Five.

Respondent has also proven by clear and convincing evidence

that Lisle intended to evade taxes known to be owing on that

income by conduct designed to conceal, mislead, or otherwise

prevent the collection of such taxes. The record contains

several indicia of Lisle's fraud with intent to evade tax.

In determining the presence or absence of fraud, we consider

the training and experience of the taxpayer. See Iley v.

Commissioner, 19 T.C. 631, 635 (1952). Lisle graduated from the

University of Missouri with a B.S. degree in public

administration. He attended law school at the University of

Missouri, graduate schools of management and business at Columbia

University, and the graduate school of management at Princeton

University. Lisle was an experienced and sophisticated

businessman who held high executive positions at Prudential and

later at Travelers. As such, he obviously understood and fully

appreciated his obligation to report income correctly and to pay

taxes on that income. Nevertheless, he disregarded this
 - 304 -

obligation by participating in various schemes to collect

kickbacks from the Five and misdirect income through Kanter's

maze of entities.

Consistent and substantial understatements of income are

strong evidence of fraud. See Marcus v. Commissioner, 70 T.C.

562, 577 (1978), affd. without published opinion 621 F.2d 439

(5th Cir. 1980). Moreover, a pattern of consistent

underreporting of income, when accompanied by other circumstances

indicating an intent to conceal income justifies the inference of

fraud. See Holland v. United States, 348 U.S. 121, 137 (1954).

Lisle omitted income received from transactions with the Five

during the years 1984 and 1987 through 1989 in the total amount

of $1,280,547. Additionally, for the years 1978 through 1983,

1984, and 1985, years not before us here, he omitted $2,734,707.

Lisle allowed Kanter to commingle his share of the kickback

moneys in the laundering mechanism Kanter created to conceal the

true nature of the income and the identity of the earner of the

income. Lisle’s use of the various Kanter sham entities

(including among others, IRA, Carlco, KWJ Corp., KWJ Co., Essex,

Zeus, Holding Co., Int’l Films, HELO, Administration Co., and

Principal Services) made it difficult and sometimes impossible to

trace the cash-flow and is substantial evidence of Lisle’s intent

to evade tax. See Scallen v. Commissioner, supra at 1371.

Commingling by laundering is an indication of fraudulent intent.
 - 305 -

See United States v. Jackson, 983 F.2d 757 (7th Cir. 1993).

Commingling of the kickbacks in the accounts of the conduit

entities, together with other unrelated income, was a device to

hide the kickbacks from Prudential and the IRS, and is evidence

of fraud. See Maddas v. Commissioner, 114 F.2d 548 (3d Cir.

1940).

There is fraud where there is a scheme to "thwart the

effective functioning of the IRS" and where there is an attempt

to disguise the source of income. See United States v. Browning,

723 F.2d 1544, 1547 (11th Cir. 1984). Lisle plainly attempted to

disguise the source of the kickback funds by the manner employed

in sending the moneys through a roundabout method over a period

of many years through Kanter's conduit entities. To be sure, the

movement of the moneys had no legitimate business purpose, as

demonstrated by the evidence.

The use of nominees, placing money or property in the name

of another, is indicative of fraud. See United States v.

Peterson, 338 F.2d 595 (7th Cir. 1964); Furnish v. Commissioner,

supra, where the Court of Appeals stated that "Concealment by

itself is indicative of a willful intent to evade income taxes."

Lisle used IRA and later Carlco as a nominee to receive and hold

and conceal the kickback payments he received for his services.

Failure to cooperate with revenue agents during an audit

examination is indicative of fraud. See Bradford v.
 - 306 -

Commissioner, 796 F.2d 303 (9th Cir. 1986), affg. T.C. Memo.

1984-601. As reflected in our findings of fact, Lisle did not

cooperate with respondent's agents at various stages of their

investigation of his tax returns. He withheld relevant documents

and information involving transactions with the Five.

Destruction of records and attempts to place records beyond

the reach of the revenue agents are evidence of fraud. See

Prokop v. Commissioner, 254 F.2d 544 (7th Cir. 1958), affg. T.C.

Memo. 1957-75; Estate of Beck v. Commissioner, 56 T.C. 297

(1971). We find that Lisle discarded and permitted others,

including Kanter, Gallenberger, and Weisgal, to discard

supporting income documentation, which was an intentional act

designed to conceal and evade the reporting and payment of

Federal income tax.

Misleading statements or actions are evidence of fraud. See

McManus v. Commissioner, T.C. Memo. 1972-200, affd. without

published opinion 486 F.2d 1399 (4th Cir. 1973). Lisle made the

following misleading statements to the IRS agents who interviewed

him during their examination of Kanter's returns:

(1) Lisle told the agents that Schaffel had transacted

business with Prudential prior to Kanter’s introduction of

Schaffel to Lisle;
 - 307 -

(2) he told the agents that he was not aware of the dispute

between Kanter and Schaffel regarding kickbacks for Travelers'

deals;

(3) he told the agents that he was not aware of any

agreement between Schaffel and Kanter to share commissions

Schaffel earned from the introduction to Ballard and Lisle.

(4) he told the agents that Kanter mainly dealt with the

field offices when introducing people to Prudential for business;

(5) he denied any knowledge of the Christie Trust

established for the benefit of his children;

(6) he denied any knowledge of the Christie Trust's

ownership of Carlco stock; and

(7) he claimed that he had only recently learned about

loans made by the Kanter entities to his family trusts and denied

that any loans had been made to him.

Lisle's pattern of consistent and substantial underreporting

of income, along with other indicia indicating an intent to

conceal income, justifies our finding that Lisle's underpayment

of tax attributable to the income he omitted from transactions

involving the Five is attributable to fraud.

2. Ballard's Fraud

Respondent has proven by clear and convincing evidence that

Ballard underpaid his taxes for each of the years at issue

attributable to omitted income from transactions related to the
 - 308 -

Five. Respondent has also proven by clear and convincing

evidence that Ballard intended to evade taxes known to be owing

on that income by conduct designed to conceal, mislead, or

otherwise prevent the collection of such taxes. There are

several indicia of Ballard's fraud with intent to evade tax.

Although Ballard's educational background is not in the

record, he was a sophisticated and experienced businessman who

held high executive positions at Prudential, and later at Goldman

Sachs. As such, he obviously understood and fully appreciated

his obligation to report income correctly and to pay taxes on

that income. Nevertheless, he disregarded this obligation by

participating in various schemes to collect kickbacks from the

Five and misdirect income through Kanter's maze of entities.

As our findings show, Ballard omitted income received from

transactions with the Five during the years 1978 through 1982,

1984, and 1987 through 1989 in the total amount of $3,054,093.

Additionally, for the years 1983, 1985, and 1986, years not

before us here, he omitted $961,161.

Ballard used IRA and later TMT as a nominee to receive and

hold the kickback payments he received for his services.

Ballard did not cooperate with respondent's agents at

various stages of their investigation of his tax returns. He

withheld relevant documents and information involving

transactions with the Five.
 - 309 -

Ballard discarded and permitted others, including Kanter,

Gallenberger, and Weisgal, to discard supporting income

documentation, an intentional act designed to conceal and evade

the reporting and payment of Federal income tax.

Ballard allowed Kanter to commingle his share of the

kickback moneys in the laundering mechanism Kanter used to

conceal its identity. Ballard’s use of the various Kanter sham

entities (including among others, IRA, TMT, KWJ Corp., KWJ Co.,

Essex, Zeus, Holding Co., Int’l Films, HELO, Administration Co.,

and Principal Services) made it difficult and sometimes

impossible to trace the cash-flow and is substantial evidence of

Ballard’s intent to evade tax. Commingling the kickbacks in the

accounts of the conduit entities, together with other unrelated

income, was a device to hide the kickbacks from Prudential and

the IRS, and is evidence of Ballard's fraud.

Ballard plainly attempted to disguise the source of the

kickback funds by funneling money in the roundabout method

through the conduit entities over a period of many years.

Ballard made the following misleading and false statements:

(1) He testified that at the dinner meeting where Kanter

introduced Schaffel to Ballard and Lisle, they only discussed

politics, football, and religion, and that no business was

discussed;
 - 310 -

(2) he testified that he did not know whether Walters had

transacted any business with Prudential when Ballard was at

Prudential and that he was not involved with the Ramada

Renaissance property; yet he met with Schaffel and Walters to

finalize the financing of the Cherry Creek Place II and the

Ramada Renaissance properties;

(3) he testified that Prudential did not purchase the

Schnitzer-PMS stock because, apart from the potential conflict of

interest, Prudential did not have any business to give to

Schnitzer-PMS; yet Prudential started giving Schnitzer-PMS

substantial business;

(4) he testified that he had no involvement and no meetings

with Connolly other than seeing him at the Gateway hotel; yet he

is the person who introduced Connolly to Eulich for purposes of

setting up the Essex arrangement.

Finally, we find Ballard's testimony vague, evasive, and

unreliable as to the kickback payments in the face of

overwhelming evidence to the contrary.

Ballard's pattern of consistent and substantial

underreporting of income, when accompanied by the other indicia

indicating an intent to conceal income, justifies our finding

that Ballard's underpayment of tax attributable to income he

omitted from transactions involving the Five is attributable to

fraud.
 - 311 -

3. Kanter's Fraud

Kanter was the architect who planned and executed the

elaborate scheme with respect to the kickback income payments

received from the transactions involving the Five. Ballard and

Lisle participated with him, shared in the payments, and

cooperated in the diversions. In our view, what we have here,

purely and simply, is a concerted effort by an experienced tax

lawyer and two corporate executives to defeat and evade the

payment of taxes and to cover up their illegal acts so that the

corporations, Prudential and Travelers, and the Federal

Government would be unable to discover them.

Respondent has proven by clear and convincing evidence that

Kanter underpaid his taxes for each of the years at issue

attributable to transactions related to the Five. Respondent has

also proven by clear and convincing evidence that Kanter intended

to evade taxes known to be owing on that income by conduct

designed to conceal, mislead, or otherwise prevent the collection

of such taxes.

The record is replete with several indicia of Kanter's

fraud. They are:

First, Kanter has a legal education. He has been a

practicing tax attorney since 1956. He has taught courses in

estate and gift taxation and estate planning at the University of

Chicago Law School. He has lectured and written extensively in
 - 312 -

the area of Federal tax law. For a number of years, he has been

a writer and contributor to the Journal of Taxation, a national

monthly publication devoted exclusively to Federal taxation.

Kanter, as an experienced tax attorney, obviously understood and

fully appreciated his legal obligations to report income

correctly and to pay taxes on that income. Nevertheless, he

disregarded these obligations by conceiving and carrying out

various schemes to misdirect income. Furthermore, he was or

should have been aware that his Federal income tax liabilities

were substantially underreported for each of the years in issue.

Second, as we have previously found, Kanter reported

adjusted gross losses on his Federal income tax returns for every

year from 1978 through 1989. For 11 of those years he paid no

Federal income taxes, and only minimum tax of $1,671 in 1978.

Kanter omitted income received from transactions with the Five

during the years 1978 through 1989 (except for 1985) in the total

amount of $3,422,469. Even for 1985, a year not before us here,

he omitted $1,592,939.

Third, Kanter created a complex laundering mechanism made up

of sham corporations and entities (including among others, IRA,

Carlco, TMT, BWK, Inc., KWJ Corp., KWJ Co., Essex, Zeus, Holding

Co., Int’l Films, HELO, Administration Co., and Principal

Services) to receive, distribute, and conceal his income, as well

as Ballard’s and Lisle’s income. Payments made for their
 - 313 -

services were paid to IRA and Holding Co. or one of their

subsidiaries. The payments were commingled with funds from other

entities in Administration Co.’s accounts and later Principal

Service’s accounts. Large amounts of money were distributed to

various entities and individuals, including Kanter, Ballard, and

Lisle, through IRA, Holding Co., HELO, Int’l Films, and the Bea

Ritch trusts. The distributions were disguised as loans and

recorded as receivables. The receivables were shuffled (through

book entries) between the various entities and eventually written

off. Kanter’s use of the various sham entities made it difficult

and sometimes impossible to trace the flow of the money and is

substantial evidence of his intent to evade tax. See Scallen v.

Commissioner, 877 F.2d 1364, 1370-1271 (8th Cir. 1989).

Fourth, as reflected in our findings of fact, Kanter did not

cooperate with respondent's agents at various stages of their

investigation of his tax returns. He withheld relevant documents

and information involving transactions with the Five and the

movement of moneys through the conduit entities such as

Administration Co., IRA, Holding Co., and others.

Kanter caused some records to be destroyed and attempted to

place other records beyond the reach of the revenue agents

conducting the investigation. We find in particular that

destruction of records that were the subject of the IRS summonses

after the issuance of the summonses to be a strong indication of
 - 314 -

fraud. "The summons had no time limit, was never withdrawn, and

* * * required the recipient to retain--indefinitely--the

documents within its scope." United States v. Administrative

Enters., Inc., 46 F.3d at 673.

Gallenberger and Weisgal claim that records had been

discarded pursuant to a 3-year retention policy based on the

normal 3-year statute of limitations for assessing tax

deficiencies. Yet the records they destroyed related to returns

that were being audited and were the subject of IRS

administrative summonses. We think that such a 3-year retention

policy could not justify the destruction of corporate minutes,

stock ownership records, or resolutions by the boards of

directors. Moreover, some of the entities involved were trusts

or corporations owned by trusts. Corporate officers and

directors, as well as trustees of trusts, are often required to

account to shareholders and beneficiaries for periods greater

than 3 years. None of the individuals involved with the various

entities (Gallenberger, Weisgal, Meyers, and Schott) acted in any

independent manner. They all acted as directed by Kanter. It is

clear that they destroyed the records at Kanter's direction.

Kanter, a tax professional who represents clients before the

IRS and this Court, is aware of the need for documentation and

records to support the items reported on tax returns. In light

of that knowledge, coupled with other evidence, we find that his
 - 315 -

discarding of his supporting income documentation was an

intentional act designed to conceal and evade the reporting and

payment of Federal income tax.

Fifth, Kanter's commingling of his income with the moneys of

others is an indication of fraud in an attempt to avoid tax.

United States v. Walton, 909 F.2d 915 (6th Cir. 1990). The use

of IRA and the other entities by Kanter and the commingling of

the kickback moneys were part of the laundering mechanism

designed by Kanter. All of the commingling of Kanter's income,

as well as that of Ballard and Lisle, was done at his direction.

Commingling of the kickbacks in Administration Co.'s accounts,

together with other unrelated income, was designed to conceal the

kickbacks. The commingling and laundering are evidence of fraud.

Maddas v. Commissioner, 114 F.2d 548 (3d Cir. 1940); United

States v. Jackson, supra.

Sixth, Kanter's scheme was intended to "thwart the effective

functioning of the IRS" and was an attempt to disguise the source

of income. Kanter plainly attempted to disguise the source of

the kickback funds by the manner employed in sending the moneys

through conduit entities in a roundabout method over a period of

many years. Obviously, he, as well as Ballard and Lisle, did not

want Prudential and Travelers to know about the kickback

payments. Certainly, the movement of the moneys had no

legitimate business purpose.
 - 316 -

Seventh, Kanter's reporting of the kickback moneys on the

returns of IRA and Holding Co. was designed to conceal the

scheme, and is another strong indication of Kanter's fraud. See

Lang v. Commissioner, T.C. Memo. 1961-134, where the reporting of

income from property beneficially owned by the taxpayer on the

returns of family members was held to be fraudulent. It is clear

that Kanter used the sham corporations to give the appearance

that the kickback income was earned by them, rather than Ballard,

Lisle, and himself, and that there was no tax due by the

corporations because there were claimed losses sufficient to

offset the income. Moneys were distributed from IRA and Holding

Co. at Kanter's direction to other entities that were created to

conceal further the true nature of the payments. Three of those

entities, TMT, Carlco, and BWK Inc., were controlled respectively

by Ballard, Lisle, and Kanter, and were the repositories of the

kickback moneys distributed from IRA.

Eighth, Kanter routinely used the various conduit entities

as nominees, placing money and property in the names of the

entities to conceal the transactions. In fact, when it was

convenient, he would assert that the entity held an asset merely

as nominee.

Ninth, Kanter created phony loans to disguise the

distributions of the income to himself and others and to evade

the income tax due on the income. He later arranged for sales of
 - 317 -

the receivables for nominal amounts in order to claim false bad

debt deduction losses and offset additional income reported on

his returns and the returns of the conduit entities.

Tenth, as discussed previously, Kanter's testimony at trial

was implausible, unreliable, and sometimes contradictory. We did

not find it credible.

Finally, other factors that support a finding of Kanter's

fraud include, but are not limited to, manipulations of

deductions and income between various corporate, partnership, and

trust entities to conceal not only his income but the income of

others; failure to account for payments for services; and the use

of the various artifices to divert the payments to his children

and trusts benefiting his family.

Kanter's substantial understatements of income over an

11-year period, his intentional misdirection of income, and his

deliberate mischaracterizations of the transactions are clear and

convincing evidence of his fraudulent intent to evade taxes,

particularly in light of his legal education and experience and

overall tax sophistication. See Scallen v. Commissioner, 877

F.2d 1364, 1370-1371 (8th Cir. 1989); Sisson v. Commissioner,

T.C. Memo. 1994-545, affd. without published opinion 108 F.3d 339

(9th Cir. 1996); Wheadon v. Commissioner, T.C. Memo. 1992-633.

The transactions involved here were masquerades, concealing

the true character of the payments. In reality, an attorney and
 - 318 -

two highly successful businessmen conspired to conceal millions

of dollars of kickbacks, using a multitude of entities with

friends and employees serving as officers of convenience, in an

attempt to defraud the employers of Ballard and Lisle and evade

taxes properly owed to the Government.

As each layer of Kanter's complex organization is removed,

and the flow of the money is followed, the magnitude of the fraud

is revealed. Kanter's explanations are mere platitudes and

rationalized rhetoric intended to obfuscate the true character of

the transactions and his wrongdoing.

F. Summary and Conclusions as to Fraud

The addition to tax or penalty in the case of fraud is a

civil sanction provided primarily as a safeguard for the

protection of the revenue and to reimburse the Government for the

heavy expense of investigation and the loss resulting from the

taxpayer's fraud. Helvering v. Mitchell, 303 U.S. 391, 401

(1938). The facts, as we have found in detail, clearly show that

Kanter, Ballard, and Lisle, through the use of various conduit

entities, devised a multifaceted scheme to shield kickback

payments they received from transactions involving the Five.

Their fraud resulted in the Federal Government not being paid

several millions in income taxes due and owing. Clearly, the

Government incurred great expense investigating petitioners'
 - 319 -

returns. The investigation took years and involved the efforts

of dozens of IRS agents and several Government attorneys.

Petitioners created profitable business deals between the

Five and Prudential and Travelers. The large sums of money they

received as kickbacks were diverted at Kanter's direction to

their controlled conduit entities. To effectuate the part of the

scheme involving the Prudential transactions, Kanter through his

related entities (IRA and its subsidiaries), retained the moneys

for a period of time until they were distributed directly or

indirectly to Ballard, Lisle, and himself in a 45-45-10 percent

split. To effectuate the remaining part of the scheme involving

the payments for Kanter's services, including payments from the

Schaffel/Travelers transactions, Kanter caused the moneys to be

paid to Holding Co., which he controlled.

As a result of the overall scheme, over $13 million of

kickback and other income was omitted by petitioners

collectively. The evidence is clear and convincing that they

intended to evade the payment of their taxes on such omitted

income. Accordingly, after considering all the facts and

circumstances contained in the massive record of these cases, we

hold that Kanter, Ballard, and Lisle are liable for the fraud

additions to tax and penalties for each of the years at issue.
 - 320 -

Issue 2. Whether Certain Commitment Fees Paid to Century
Industries, Ltd., Are Includable in Kanter's Income for 1981,
1982, 1983, 1984, and 1986

FINDINGS OF FACT

Century Industries, a partnership, was organized in 1979.

Its partners were the Bea Ritch trusts, Weisgal individually

(rather than as trustee of the Bea Ritch trusts), and a third

individual. The 25 trusts (collectively), Weisgal, and the other

individual 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. The third

individual referred to above withdrew from the partnership, new

partners were admitted, and the partnership's investment focus

was changed. The new partners included Kanter, four family

trusts for the benefit of Weisgal's family members (the James

Children's Trust, the Lawrence Children's Trust, the Lee

Children's Trust, and the Richard Children's Trust), and another

investment partnership composed of irrevocable trusts for the

benefit of Weisgal's family called Atlay Valley Investments

General Partnership (Atlay partnership).
 - 321 -

During 1980 and 1981, the partners in Century Industries,

their capital interests, and their initial capital contributions

were as follows:

Partners Partnership Int. Capital Contrib.

Atlay partnership 29 percent $290
Bea Ritch trusts 49 percent 490
James Children's trust 5 percent 50
Lawrence Children's trust 5 percent 50
Lee Children's trust 5 percent 50
Richard Children's trust 5 percent 50
Kanter 1 percent 10
Weisgal 1 percent 10

In 1984, Cypress Lane Investment (a general partnership

consisted of 30 irrevocable trusts for the benefit of Weisgal's

family) replaced Atlay partnership as a 29-percent partner in

Century Industries.

Century Industries had no office or employees of its own and

operated out of the accounting firm offices of Weisgal. Although

Century Industries considered and evaluated a number of potential

investments from 1981 through about 1988, it made only a

relatively small number of investments until about 1987. After

1981, its partners were not required to make additional capital

contributions until 1986. During 1986 and 1987, its partners

made the following additional capital contributions:
 - 322 -

1986 Capital 1987 Capital
Partner Contrib. Contrib.

Bea Ritch trusts $29,900 $53,400
Cypress Lane Inv. 17,900 31,900
James Children's trust 3,000 5,500
Lawrence Children's trust 3,000 5,500
Lee Children's trust 3,000 5,500
Richard Children's trust 3,000 5,500
Kanter 6,100 3,600
Weisgal Revocable trust 6,100 3,600

From 1981 through 1986, Century Industries received "standby

commitment fees" from the following entities in the amounts

indicated:

Payer 1981 1982 1983 1984 1985 1986
Bayshore Marina -- -- -- -- -- $50,000
Century Capital -- $3,000 -- -- -- --
City & Suburban -- -- -- -- $3,000 --
Dist.
Computer Place- $13,500 7,000 -- -- -- --
ment Services
CPS Inv. -- -- $500 $2,000 3,500 --
Delphi Indus. -- -- -- -- 3,000 --
IRA 4,000 3,000 -- -- 4,000 --
James Ins. Tr. -- -- 5,000 -- -- --
Ry. Placement -- -- 4,500 -- -- --
Services
Satcorp -- -- -- 75,000 -- --
SiLite, Inc. 17,500 7,000 18,000 13,000 11,000 12,000
Stockholder -- -- -- 3,000 -- --
TAC -- -- -- -- 4,500 --
Holding Co. -- -- 1,000 -- -- --
Waco Capital -- -- -- -- 1,000 --
Zion -- -- 4,000 -- -- --
35,500 20,000 33,000 93,000 30,000 62,000

One of the entities paying commitment fees, SiLite, Inc.

(SiLite), had a history of acquiring other companies. During the

years at issue, SiLite paid a monthly retainer of $1,000 to

Century Industries for evaluation of investment opportunities.

In addition to the monthly retainer, SiLite occasionally paid

additional amounts for the analysis of investment opportunities.
 - 323 -

Kanter and Weisgal performed the analyses for which payments were

made to Century Industries.

On February 1, 1984, Century Industries billed Satcorp

$100,000 for consultation, analysis, and recommendations

regarding the financing and structuring of investment

opportunities, specifically the structuring of a limited

partnership and the sale of units in the partnership. A letter

agreement dated September 12, 1984, sets forth the purpose of the

payments made by Satcorp to Century Industries. The letter

agreement provides:

This letter will briefly outline the relationship
between [sic] Satcorp, Inc. ("Satcorp") and Century
Industries, Ltd. ("Century") so as to encompass Burton
Kanter and Solomon Weisgal serving as so-called
"financial engineers" for Satcorp and its existing
operating companies and other projects it may
undertake. The scope of involvement will be
principally planning and structuring of transactions
for financings for Satcorp, its operating companies and
its future projects. It is intended that Century will
consider participating in the actual process of raising
financings, subject to fee arrangements to be agreed
upon in connection therewith, but will not be routinely
responsible for any such activities.

To accommodate the foregoing and the overall
relationship as it has been discussed, Century will
bill fees in addition to those outlined below for
services performed in connection with specific
ventures, provided all conflicts are disclosed and the
decision with respect to building in such fees has
carefully and conscientiously [sic] taken into account
any impact on successful fund raising.

The specific current engagement will be compensated as
follows:
 - 324 -

1. Fees

a) Century will be guaranteed payment of $100,000 to
be paid over a period of 18 months from January 1,
1984; specifically, $25,000 to initiate the
engagement (already received), $25,000 90 days
thereafter (already received), and the balance to
be paid in equal monthly increments over the 12
months commencing July 1, 1984.

b) In addition, Century will maintain records of the
billings and time allocated so that if it "runs
over" within the first 12 months, based on usual
hourly rates, Century will be paid the difference
as billed.

Whenever possible Century will apply its fees to
individual offerings of finance, so as to spread the
burden to various projects.

2. Equity

a) Century will vest to an amount of share equivalent
to 7.5% of the outstanding common stock of Satcorp
as computed on December 8, 1983 to be issued * * *
[during 1984 and 1985].

b) It is to be understood that in the event of death
or permanent disability of either Burton Kanter or
Solomon Weisgal, at Satcorps [sic] option it may
request that the aforementioned shares be
redelivered and exchanged for non-voting shares
representing in all other respects the same equity
interest as represented prior to the exchange.
The purpose of this option is to accommodate
Century's desire to maintain a continuing equity
interest without being subject to redemption or
other call, but at the same time to be certain
that Satcorp is completely comfortable with those
persons or entities who may succeed to the
stockholdings in those circumstances mentioned.

In a letter dated November 20, 1984, to John Geocaris, City

& Suburban Distributors, Inc., written by Weisgal on Century

Industries letterhead, Weisgal stated:
 - 325 -

Burt [Kanter] and I have gotten our thoughts together
and reviewed all of our records regarding the time that
we have spent from inception of our conversations
through October 31, 1984.

The enclosed bill for $6,000 represents the dollar
reflection of the time involved. We have addressed
this bill to City & Suburban Distributors, Inc. and I
presume that this is the correct entity.

If for some reason you would prefer this charge billed
to a different company, please let me know.

The referenced bill indicates that the $6,000 charge was for

special tax and consulting services. A second letter to

Geocaris, dated December 26, 1984, describes the work performed

as overall financial planning, consideration of leveraged debt

financing, considerations 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.

Century Industries issued an invoice dated February 24,

1986, to Bayshore Marina, Ltd., for $50,000 for various

consulting services rendered from 1983 through 1985.

From 1983 through 1986, Kanter and Weisgal received the

following guaranteed payments from Century Industries:

Year Kanter Weisgal

1983 $2,000 $2,000
1984 12,000 --
1985 7,500 --
1986 6,000 6,000
 - 326 -

Beginning in about 1987, Century Industries made certain

investments that required additional capital contributions from

its partners. Some of these investments proved to be

unsuccessful. Ultimately, in 1988 or 1989, the partnership was

dissolved. Its affairs were wound up, and its remaining

investments with any value were distributed to the partners.

During the years at issue, Century Industries reported its

income on the calendar year and filed Forms 1065 U.S. Partnership

Returns, for each of its taxable years.

In notices of deficiency issued to the Kanters for 1981,

1982, 1983, 1984, and 1986, respondent determined that the

commitment fees paid to Century Industries constituted Kanter's

income for those years. Respondent issued a notice of final

partnership administrative adjustment (FPAA) to Century

Industries reallocating some of the partnership's 1986 income to

Kanter.51 No FPAA was issued to Century Industries for 1983 and

1984.

OPINION

The issue we decide is whether the commitment fees paid to

Century Industries are includable in Kanter's income for taxable

years 1981, 1982, 1983, 1984, and 1986. Respondent determined

51
A petition has been filed with this Court challenging the
FPAA with respect to Century Industries' 1986 tax year. Century
Indus. Ltd., Solomon A. Weisgal Revocable Trust, Solomon A.
Weisgal, Co-Trustee, Tax Matters Partner v. Commissioner, docket
No. 11559-90.
 - 327 -

that the commitment fees paid to Century Industries were actually

earned by Kanter and assigned by him to Century Industries.

Respondent now concedes that half the fees were for services

provided by Weisgal. Kanter contends that before Century

Industries would consider investing in a proposed venture,

Century Industries charged commitment fees for evaluating the

proposed investment, and, thus, the fees are income of the

partnership. Additionally, for the 1983, 1984, and 1986 taxable

years, Kanter maintains that the Court does not have subject-

matter jurisdiction to decide the deficiencies related to the

commitment fees determined in the notices of deficiencies because

he contends for those years Century Industries is subject to the

partnership audit and litigation provisions found in subchapter C

of chapter 63 of subtitle F of the Internal Revenue Code. These

provisions, sections 6221 through 6233 (collectively referred to

for convenience as the TEFRA partnership provisions), are

generally applicable to specified partnerships and other entities

filing partnership returns for taxable years beginning after

September 4, 1982. Tax Equity and Fiscal Responsibility Act of

1982 (TEFRA), Pub. L. 97-248, sec. 407(a)(1), (3), 96 Stat. 324,

648.

Under the TEFRA partnership provisions, the tax treatment of

partnership items must be determined at the partnership level.

Sec. 6221. A partnership item must be considered solely in the
 - 328 -

partnership proceeding and cannot be considered in the partner's

personal or individual case. Disputes relating to

"nonpartnership items", however, continue to be resolved at the

individual partner level.

Section 6231(a)(3) provides that a "partnership item" means

any item required to be taken into account for the partnership's

taxable year to the extent prescribed by regulations as an item

that "is more appropriately determined at the partnership level

than at the partner level." The regulations provide that

partnership items include the partnership's aggregate and each

partner's share of items of income.

If the commitment fees were Kanter's income that he assigned

to the partnership, then the asserted deficiency against him from

the adjustment would not be attributable to a partnership item,

and consideration of the adjustment in the instant cases will not

be enjoinable pursuant to section 6225(b). See sec. 6225(a) and

(b). The adjustment to Kanter’s income further would not be an

"affected item". Sec. 6231(a)(5); NCF Energy Partners v.

Commissioner, 89 T.C. 741, 743-746 (1987); Maxwell v.

Commissioner, 87 T.C. 783, 792-793 (1986). Conversely, if the

fees are the partnership's income, the determination of a

partner's share of the income is a partnership item and must be

made at the partnership level. See sec. 6231(a)(1), (3); Rule

240(b)(2); see also Maxwell v. Commissioner, supra at 787-788.
 - 329 -

Thus, we must first determine whether the fees are Kanter's

income. We must consider all the facts and circumstances to

determine the actual earner of income. See Leavell v.

Commissioner, 104 T.C. 140, 155 (1995). From 1981 through 1986,

a number of entities paid substantial commitment fees to Century

Industries. The Kanters contend that Century Industries required

the entities to pay the partnership the commitment fees for the

partnership to consider investing in a proposed transaction. The

evidence, however, shows that the payments made by the entities

were for services provided by Kanter and Weisgal to the entities

and that the services were unrelated to any investments made by

Century Industries. For example, Satcorp agreed to pay Century

Industries $100,000 plus stock in Satcorp to acquire Kanter's and

Weisgal's services as "so-called financial engineers" to assist

in the structuring of a limited partnership and the sale of the

units in the partnership.

The evidence shows that the commitment fees were paid for

professional and promotional services rendered by Kanter and

Weisgal to the entities that paid the fees. The November 20,

1984, letter from Weisgal to John Geocaris requests that the fees

were for special tax and consulting services. The letter states

that "Burt and I have gotten our thoughts together and reviewed

all of our records regarding the time that we have spent from

inception of our conversations through October 31, 1984." Kanter
 - 330 -

and Weisgal were required to account for their time and the

$6,000 fee was based on that time. Although some of the

commitment fees were paid by entities related to Kanter or

Weisgal, the Kanters have provided no documents to show that the

commitment fees paid by those entities were for Century

Industries' consideration whether to purchase investments offered

by those entities.

Century Industries was not a partnership formed by a group

of professionals, such as doctors, lawyers, or accountants,

through which the professionals practice together. Kanter (an

attorney) and Weisgal (an accountant) were the only partners in

Century Industries who were professionals. Each individually

owned only 1 percent of the partnership interests. Their family

trusts owned the remaining 98 percent. Kanter and Weisgal used

Century Industries to assign to the family trusts the fees they

received for professional and promotional services.

We find that the commitment fees were for professional and

promotional services provided by Kanter and Weisgal and that they

are the true earners of the income. Therefore, the income is not

the income of Century Industries, and this Court has jurisdiction

over the adjustments made in the notices of deficiencies.

Respondent concedes that only half of the fees are Kanter's

income. Kanter has not provided time records or any other

evidence to establish that he may have provided less than half of
 - 331 -

the services or that less than half of the fees is his income.

We hold, therefore, that one half of the commitment fees received

by Century Industries for the taxable years 1981, 1982, 1983,

1984, and 1986 are includable in Kanter's income for those years.

Issue 3. Whether Kanter Received Unreported Income From Hi-
Chicago Trust for 1981, 1982, and 1983

FINDINGS OF FACT

In notices of deficiency for 1981, 1982, and 1983,

respondent determined that Kanter failed to report income

received from the Hi-Chicago Trust (HCT) in the amounts of

$42,720, $19,247, and $109,399, respectively.

At trial and in a stipulation of settled issues, Kanter

conceded the unreported income adjustment for 1981 but did not

concede the adjustments for 1982 and 1983 or the additions to tax

for 1981, 1982, and 1983 relating thereto.

HCT was established on March 6, 1972, by and between

Benjamin Markowe, as grantor, and Kanter, as trustee. The

beneficiaries of HCT were Sylvia Federman (the wife of Hyman L.

Federman (Federman)) and the children of Federman and Sylvia

Federman; namely Miles Federman, Ruth Silverstone, and Joan

Priver. The HCT agreement conferred broad powers upon the

trustee, including, but not limited to, the power to buy and sell

property and pay any reasonable compensation to the trustees.

Kanter served as trustee from the inception of the HCT through at
 - 332 -

least 1989. By its terms, HCT was governed by the laws of the

State of Illinois.

Neither Kanter nor members of his family were beneficiaries

of HCT. Kanter is not related to Federman but is a friend of

Federman and the trustee of HCT.

At the inception of HCT, Federman and the beneficiaries of

HCT orally agreed with Kanter that Kanter (or his designee) would

at all times during the continuance of HCT be entitled to

participate in the investments of HCT by way of a so-called

carried interest to the extent of 10 percent of any and all

profits realized from time to time by HCT on its individual

investments. Such profits were to be payable upon disposition of

any specific investment, whether an investment was in the form of

a note, stock, securities, partnership interest, or other forms

of property but excluding any interest income realized on

deposits, such as savings accounts, certificates of deposit, time

deposits or debt instruments. Kanter had the option to exercise

his right to the carried interest by electing a distribution in

kind of any investment held by the trust to which the carried

interest applied. If Kanter elected a distribution in kind, HCT

made a distribution to Kanter or his designee of a 10-percent

interest in the investment in consideration for a payment by

Kanter or his designee to HCT of 10 percent of HCT's cost of the
 - 333 -

investment. Kanter did not otherwise pay a fee to HCT for this

carried interest.

During the years in question, Kanter, as trustee, performed

various services for HCT. He determined whether investments by

HCT would be made and whether and when they would be sold. His

decisions on these matters were final. Kanter made the decisions

as to whether or not distributions would be made to the

beneficiaries; he directed people who worked for him at his law

firm and then later at Administration Co. and Principal Services

to perform various administrative services for HCT; he supervised

them in the performance of these services and, as trustee, he was

responsible for the performance or non performance of these

services. Kanter signed the tax returns of HCT; he hired the

accounting firm of Oppenheim, Appel & Dixson to prepare some of

the tax returns of HCT; and he subjected himself to liability

under VIII, paragraph 8.3 of the HCT agreement for any willful

default, wrongdoing, or gross negligence in connection with his

duties as trustee of HCT.

On December 22, 1980, Kanter sent a letter to Federman

enclosing a document entitled “Agreement and Indemnification”.

As stated in the letter, the enclosed Agreement and

Indemnification reflected the agreement concerning the carried

interest. The Agreement and Indemnification document was not

executed at that time.
 - 334 -

In order to induce Kanter to continue to serve as trustee

and to reduce to writing the agreement concerning the carried

interest, the Agreement and Indemnification was entered into on

July 26, 1984, by and among (1) Kanter, as trustee of HCT, (2)

the beneficiaries of HCT, and (3) Hyman L. Federman. The

Agreement and Indemnification stated, in pertinent part, as

follows:

WHEREAS, BWK is currently acting as Trustee of the
Hi-Chicago Trust and so acted from its inception at the
time of creation; and

WHEREAS, the Beneficiaries of the Trust desire
that BWK continue to serve as Trustee of the Trust; and

WHEREAS, BWK is willing to so serve, upon receipt
of a satisfactory release and indemnification as
contained herein from the Beneficiaries and from HLF,
with respect to any and all claims and liabilities
which might be asserted concerning prior conduct by BWK
as Trustee in the operations of the Trust, and for
acting or choosing not to act upon advice provided by
HLF; and

WHEREAS, all of the undersigned have expressed a
willingness to execute this Agreement and
Indemnification in order to induce BWK to continue to
serve as Trustee of the Trust without seeking prior
judicial approval for his past or future acts or
failure to act as Trustee; and

WHEREAS, to provide the beneficiaries of the Trust
a current financial account there is attached hereto as
"Exhibit A" a balance sheet and profit and loss
statement as of the Trust year ended February 29, 1984,
and a further such balance sheet and profits and loss
statement as of June 30, 1984, attached as Exhibit B.

NOW, THEREFORE, the parties hereto agree as
follows:
 - 335 -

1. BWK shall hereafter continue to act as the
sole Trustee of the Hi-Chicago Trust.

2. The Trustee may, at his option, at any time,
and from time to time, seek professional investment
advice from HLF and, to the extent the Trustee may act
upon such advice, or shall choose not to act upon such
advice, he shall be exculpated from and held harmless
from and otherwise indemnified with respect to any and
all claims, demands, suits, actions, liabilities and
responsibilities arising out of or connected with
following or failing to follow such advice.

3. It is understood that at the inception of the
Trust an agreement was reached that BWK, individually,
or his designee, would at all times during the
continuance of the trust be entitled to participate in
the investments thereof by way of a so-called "carried"
interest to the extent of ten percent (10%) of any and
all profits realized from time to time by the Trust on
its individual investments, said profits interest to be
payable upon the disposition of any specific
investment, whether said investment was in the form of
a note, stock, securities, partnership interest, or
other form of property, excluding participation in any
interest realized upon deposits of the trust held for
interest only, such as savings accounts, certificates
of deposits, time deposits, or debt instruments, but
excluding any related equity property interest, subject
to the right of BWK, or his designee, at his election
with respect to any specific investment of the Trust to
which the aforesaid carried interest applies, to obtain
a distribution of a ten percent (10%) interest in said
investment in kind by payment to the Trust of ten (10%)
of the Trust's cost thereof; it is further understood
that the aforesaid agreement has heretofore, and does
presently, represent an integral part of the investment
program of the Trust; accordingly, the undersigned do
hereby ratify and consent to said agreement as
heretofore implemented and applied, and as will
hereafter be implemented and applied, in such manner as
the Trustee shall determine in accordance with
generally accepted accounting concepts of realization
of profit from each specific investment upon its
disposition for cash or other property.

4. There is attached hereto as "Exhibit A" and
"Exhibit B" a financial statement for the Trust for the
 - 336 -

period ending February 29, 1984, and June 30, 1984
including therein a balance sheet and profit and loss
statement. The undersigned hereby acknowledge that
each of them has received a copy of said Exhibits A and
B, has examined same, and is satisfied that it
represents a substantially true and correct statement
of the financial condition of the trust, and do hereby
accept and approve the contents of said Exhibits A and
B.

5. The undersigned, jointly and severally, each
for himself or herself, his or her heirs, devisees,
legatees, appointees, executors, administrators and
assigns, in consideration of Burton W. Kanter
continuing to serve as Trustee of the Hi-Chicago Trust,
without seeking judicial approval for his actions or
failures to act as Trustee, and in consideration of
Burton W. Kanter making certain investments and
undertaking commitments hereinbefore referred to, and
otherwise acting upon or choosing not to act upon the
advice of Hyman L. Federman, currently and
prospectively, for and on behalf of the Trust, and
other good and valuable consideration, receipt of which
is hereby acknowledged, do hereby irrevocably
indemnify, release, discharge and hold harmless Burton
W. Kanter, both individually and as Trustee aforesaid,
and his heirs, devisees, legatees, appointees,
executors, administrators and assigns, of and from any
and all claims, demands, suits, actions, liabilities
and responsibilities for any act or failure to act as
Trustee of the Trust, since the inception of the Trust,
and without limiting the generality of the preceding,
do hereby specifically ratify, approve and confirm all
actions of said Trustee relating to investment advice
from Hyman L. Federman, previously, currently and
prospectively with respect to the administration of the
Trust * * *

Kanter designated Holding Co. to receive the payments of the

carried interest. Pursuant to the agreement between Kanter and

the beneficiaries of HCT, HCT paid to Holding Co. the following

amounts on the following dates:
 - 337 -

Date of Amount of
Payment Payment

12/16/80 $80,000
1980 total 80,000

08/11/81 33,925
10/23/81 8,795
1981 total 42,720

10/13/82 19,247
1982 total 19,247

02/18/83 50,000
03/15/83 22,224
05/11/83 6,199
09/14/83 1,227
09/14/83 29,749
1983 total 109,399

HCT, Kanter as Trustee, filed Forms 1041, U.S. Fiduciary

Income Tax Returns, for its taxable years ended February 28,

1981, 1982, 1983, and 1984. Each of these returns was signed by

Kanter. On its returns for the taxable years ended February 28,

1981 through 1984, HCT claimed the following deductions for its

payments to Holding Co. pursuant to the carried interest:

Description Taxable Amount of
of Deduction Year Ended Deduction

Fiduciary fees 2/28/81 $80,000
Participation fees 2/28/82 42,720
Commissions 2/28/83 88,203
Commission expense 2/28/84 56,921

On its return for the taxable years ended February 28, 1982,

1983, and 1984, HCT did not claim any deduction for fiduciary

fees. Each of the returns of HCT for the taxable years ended
 - 338 -

February 28, 1981 through 1984 was handwritten and not computer

prepared.

On his Federal income tax return for 1988, Kanter reported

as miscellaneous income trustee fees from HCT in the amount of

$29,000. At the time Kanter reported income from HCT as trustee

fees on his 1988 return, Kanter knew that respondent had

determined in notices of deficiency for 1981 and 1982 that the

amounts paid by HCT to Holding Co. during those years, pursuant

to the carried interest, were taxable to him. On his Federal

income tax returns for 1980 through 1987, Kanter did not report

any income from trustee fees from HCT.

For the taxable years ended August 31, 1978 through 1987,

Holding Co. had negative taxable income and paid no Federal

income taxes. During the taxable years in question, Holding Co.

was owned by Kanter and/or trusts for the benefit of Kanter's

family.

OPINION

Under section 61, gross income includes all income from

whatever source derived, including (but not limited to)

compensation for services, including fees, commissions, and

similar items.

During the years 1981, 1982, and 1983, HCT paid to Holding

Co. $42,720, $19,247, and $109,399, respectively. The amounts

paid by HCT to Holding Co. for 1981, 1982, and 1983 equal the
 - 339 -

unreported income adjustments in the notices of deficiency mailed

to Kanter for those years. The amounts paid by HCT to Holding

Co. for 1981, 1982, and 1983 were paid pursuant to an oral

agreement between Kanter, Hyman L. Federman, and the

beneficiaries of HCT by which Kanter or his designee was entitled

to receive 10 percent of the profits from the sale of assets of

HCT (the carried interest). Kanter does not dispute that the

amounts set forth in the notices of deficiency for 1981, 1982,

and 1983 were paid by HCT to Holding Co. pursuant to the carried

interest. Kanter claims that the amounts are not taxable to him

because, prior to the years in question, he allegedly assigned

the carried interest to Holding Co.

To the contrary, respondent contends that the evidence shows

that the payments from HCT to Holding Co. were in substance

compensation to Kanter for his services as trustee of HCT.

Kanter became trustee of HCT in 1972. He served as trustee of

HCT from 1972 through at least 1989. During the years in

question, Kanter, as trustee, performed substantial services for

HCT, as set forth in our findings of fact.

Because Kanter was not related to the Federmans and Kanter's

family members were not beneficiaries of HCT, we think it is

unlikely that Kanter would have performed the various services on

behalf of the trust without compensation. Kanter could not

establish that he received any trustee fees from HCT (other than
 - 340 -

the carried interest) during the years 1982 and 1983, and/or

whether he reported any such fees on his returns for those years.

The fact that Kanter did not receive any trustee fees from HCT

(other than the carried interest) is affirmatively shown by the

HCT fiduciary income tax returns for the taxable years ended

February 28, 1982, and 1983. On those HCT returns, other than

the deduction for the carried interest payments to Holding Co.,

HCT deducted no other payments as fiduciary fees. Had HCT made

any other payment for fiduciary fees, HCT presumably would have

deducted them on its returns. Therefore, the fact that HCT

deducted no other payments as fiduciary fees for those taxable

years indicates that HCT paid no other fiduciary fees to Kanter

during those years. Except for trustee fees of $29,000 for 1988

and $3,000 for 1989, Kanter did not establish that he received or

reported on his tax returns any trustee fees from HCT (other than

the carried interest) from the inception of HCT in 1972 through

1989. In our opinion the evidence shows that the carried

interest payments were in fact compensation for Kanter's services

as trustee of HCT.

With respect to the trustee fees from HCT that Kanter

reported as income on his 1988 and 1989 returns, at the time

Kanter received those fees, he knew that respondent had

previously determined in notices of deficiency for the taxable

years 1981 and 1982 that the amounts paid by HCT to Holding Co.
 - 341 -

during those years, pursuant to the carried interest, were

taxable to him. Respondent contends that Kanter reported trustee

fees in 1988 and 1989 in a belated attempt to lend credence to

his position that the carried interest payments were independent

of any trustee fees in order to counter respondent's

determination for prior years that the carried interest payments

from HCT to Holding Co. were in substance compensation for his

services as trustee. We agree.

On the HCT fiduciary returns for the taxable years ended

February 28, 1981, 1982, 1983, and 1984, the deductions for the

carried interest payments from HCT to Holding Co. are labeled

"Fiduciary Fees", "Participation Fee", "Commissions", and

"Commission Expense", respectively. These HCT fiduciary returns

are all signed by Kanter in his capacity as trustee of HCT. The

fact that the deduction for the payment from HCT to Holding Co.

for the taxable year ended February 28, 1981, was labeled

"Fiduciary Fees" and that the deductions labeled "Participation

Fee", "Commissions", and "Commission Expense" for the subsequent

3 years were also for the carried interest payments from HCT to

Holding Co. is further evidence that the carried interest

payments from HCT to Holding Co. were in fact fiduciary fees for

services rendered by Kanter. The fact that the payments are

labeled "Participation Fee", "Commissions", and "Commissioner

Expense", is, in any event, evidence that the payments were made
 - 342 -

for services rendered by Kanter. Kanter's signature on these

returns indicates that, under penalties of perjury, he believed

that these characterizations were true and correct.

Concerning his acquisition of the carried interest, Kanter

testified that he had invested moneys with Hyman Federman and

sustained a number of losses, and that he negotiated to receive

the carried interest as "a way to allow recoupment of losses that

I had sustained in earlier years from other investments" and that

an understanding was reached that he would receive that carried

interest "at some point in time after this trust was created and

not in conjunction with its initial creation." Kanter's

testimony pertaining to his acquisition of the carried interest

was not corroborated by any other witness. He introduced no

evidence to establish the losses he allegedly sustained. His

testimony is specifically contradicted by the Agreement and

Indemnification Agreement, which states on page 2 that "It is

understood that at the inception of the Trust an agreement was

reached that Kanter" would receive the carried interest.

Kanter testified that he always considered the carried

interest as "something independent of any trustee fee." This

statement is contradicted by the HCT fiduciary income tax return

for the taxable year ended February 28, 1980. On that return,

the deduction claimed for the carried interest payment from HCT

to Holding Co. was labeled "Fiduciary Fees". The return was
 - 343 -

signed by Kanter as trustee of HCT. His signature on the return

indicates that, under penalties of perjury, he believed that the

characterization of the carried interest payment as a fiduciary

fee was true and correct. Therefore, his statement at trial that

he considered the carried interest to be "something independent

of any trustee fee" was not credible.

Kanter's testimony that the carried interest was "something

independent of any trustee fee" is further contradicted by the

fact that the agreement entitling Kanter to receive the carried

interest was embodied in the Agreement and Indemnification

Agreement to induce Kanter to continue as trustee. The fact that

the carried interest was embodied in the Agreement and

Indemnification Agreement shows that the carried interest was

part of the consideration received by Kanter to serve as trustee.

Kanter's testimony that the carried interest was not

compensation for his services as trustee is also inconsistent

with his response to the Court's questioning concerning about how

often he was paid a trustee fee. When Kanter was asked about how

often he was paid a trustee fee, he responded as to how often the

carried interest was paid. That response indicates that Kanter

believed that the carried interest payments were made as

compensation to him for his services as trustee.

Kanter failed to establish that he validly assigned the

carried interest to Holding Co. He could not specifically
 - 344 -

identify when he assigned the interest to Holding Co. except to

say that it was "sometime in the 1970's." He provided no written

assignment document, and no other witness corroborated his

testimony. He also could not remember whether Holding Co. paid

anything for the interest or how much it paid, if any. Other

than Kanter's vague and uncorroborated testimony, the only

evidence of a possible assignment is the fact that the payments

were in fact made to Holding Co. rather than Kanter. The fact

that the payments were made to Holding Co. does not establish

that the underlying contractual right to the carried interest was

assigned by Kanter to Holding Co. but only establishes that

payments were made to Holding Co. rather than to Kanter. The

Agreement and Indemnification Agreement that was executed on July

26, 1984, recites that Kanter individually or his designee was

entitled to receive the carried interest payments. If Kanter had

assigned the contractual right to the carried interest payments

to Holding Co. in the 1970's, that fact should have been

acknowledged in the Agreement and Indemnification Agreement that

was executed in 1984, long after the purported assignment to

Holding Co. In addition, Kanter admitted that he controlled when

the carried interest payments would be made when he stated that

he would not always pay the amounts due at the time a gain was

realized as called for by the agreement but would sometimes delay

the payment. Such control by Kanter is inconsistent with a valid
 - 345 -

assignment to Holding Co. He failed to show a clear

manifestation of an intention to assign the underlying

contractual right, as opposed to the payments, to Holding Co. and

also failed to show that Holding Co. paid any valuable

consideration for the claimed assignment. Moreover, even if

there had been a valid assignment of the carried interest, it was

Kanter who was the "tree" (not the carried interest) and the

payments to Holding Co. were the "fruit" of Kanter's services to

the trust. Thus, the alleged assignment by Kanter of the "fruit"

of the "tree" to Holding Co. would have been ineffective to shift

from him to Holding Co. the income tax liability on the payments.

Lucas v. Earl, 281 U.S. 111 (1930).

We conclude that Kanter failed to establish that respondent

erred in determining that he was taxable on the carried interest

payments made by HCT to Holding Co. during the years 1981, 1982,

and 1983. The facts clearly establish that the payments were

made as compensation for his services rendered to HCT. Kanter's

treatment of the carried interest is merely another attempt by

Kanter to disguise and shift his income.
 - 346 -

Issue 4. Whether Kanter is Taxable on the Income of the Bea
Ritch Trusts for 1986 and 1987

FINDINGS OF FACT

In the notice of deficiency for 1987, respondent determined

that Kanter failed to report certain income, deductions, and

losses of the Bea Ritch Trusts (sometimes BRT) which were

reportable by him as the owner of BRT. Included in the income of

BRT was 1986 net long-term capital gain from the partnerships

Hempstead-Babylon (HB), Bergen-Westchester (BW), and Yorkshire

Partners (YP) in the amounts of $1,143,248, $274,660 and

$615,460, respectively, that had been reported on BRT returns for

the fiscal year ended September 30, 1987. The capital gains of

HB, BW, and YP were attributable to the sale by those

partnerships of their interests in Long Island Cable

Communications Development Co. (LICCDC), subsequently known as

Cablevision Systems Development Co. (Cablevision). BRT

originally became a partner of HB, BW, and YP through Oyster Bay

Associates (OBA). OBA eventually distributed its interest in HB,

BW, and YP to its partners, including BRT.

The trust agreement dated January 1, 1969, established the

Bea Ritch Trusts, Beatrice K. Ritch, Grantor, as a group of 25

trusts for the benefit of members of Kanter's family. Beatrice

K. Ritch is Kanter's mother. Joel Kanter, Janis Kanter, and

Joshua Kanter are the Kanters' children. Solomon Weisgal

(Weisgal), was named trustee of each trust.
 - 347 -

Each of the 25 Bea Ritch Trusts had an employer

identification number and filed tax returns. There is no single

or individual trust or partnership named "Bea Ritch". Bea Ritch

Trusts or BRT is a reference name used to refer collectively to

the 25 trusts created by the trust agreement.

Kanter was originally a beneficiary of each of the 25 BRT

trusts. He partially renounced and disclaimed his interest in

BRT on January 6, 1971, and renounced the remainder of his

beneficial interest in BRT on January 20, 1977. He further

signed a renunciation and disclaimer of his beneficial interests

in BRT on September 15, 1978.

The original beneficiaries of BRT also included Kanter's

wife, Naomi, and their children. The original beneficiaries were

all individuals. Kanter's wife was originally a beneficiary in

nine of the trusts.

Article III of the trust agreement establishing Bea Ritch

Trusts, Beatrice K. Ritch, Grantor, provides in pertinent part as

follows:

3.1 Income and Principal. The Trustee is hereby
authorized to distribute all or as much of the net
income or principal or both of a separate trust to the
beneficiary or to any one or more of the beneficiaries
of such trust as the Trustee deems to be in the best
interests of said beneficiary or beneficiaries.

3.2 Limited Powers of Appointment. The Grantor's son
may, during his lifetime and upon his death, appoint
all or any part of the trust estate of each separate
trust of which he shall be a beneficiary to or for the
 - 348 -

benefit of any person, persons or charitable
organization[.]

Sometime prior to 1987, 60 trust beneficiaries (the various

JSK Trusts) were added to each of the 25 trusts of BRT. The

original and additional beneficiaries of each of the 25 trusts of

BRT are as follows:

Original Additional
Trust Name Beneficiaries Beneficiaries

BWK Burton Kanter JSK 1st Trust #5
JSK 2d Trust #5
JSK 3d Trust #5

Naomi Trust Naomi Kanter JSK 3d Trust #19
JSK 1st Trust #20

BN Trust Burton & Naomi JSK 1st Trust #4
JSK 2d Trust #4
JSK 3d Trust #4

Joel Trust Burton & Joel JSK 1st Trust #17
Kanter JSK 2d Trust #17

Janis Trust Burton & Janis JSK 3d Trust #15
Kanter JSK 1st Trust #16

Joshua Trust Burton & Joshua JSK 2d Trust #18
Kanter JSK 3d Trust #18

Joel Children's Burton, Naomi JSK 3d Trust #17
Trust Joel & Joel's JSK 1st Trust #18
Children living
from time to time

Janis Children's Burton, Naomi JSK 2d Trust #16
Trust Janis & Janis's JSK 3d Trust #16
Children living
from time to time

Joshua Children's Burton, Naomi JSK 1st Trust #19
Trust Joshua & Joshua's JSK 2d Trust #19
Children living
from time to time
 - 349 -

Original Additional
Trust Name Beneficiaries Beneficiaries

JL-1 Trust Burton, Joel JSK 3d Trust #11
Harriet Blum & JSK 1st Trust #12
Joel's lst child

JL-2 Trust Burton, Joel JSK 2d Trust #12
Debbie Blum & JSK 3d Trust #12
Joel's 2nd child

JL-3 Trust Burton, Joel JSK 1st Trust #13
Jeff Blum & JSK 2d Trust #13
Joel's 3d child

JA-1 Trust Burton, Janis JSK 1st Trust #9
Henry Krakow & JSK 2d Trust #9
Janis' 1st child JSK 3d Trust #9

JA-2 Trust Burton, Janis JSK 1st Trust #10
Helen Krakow & JSK 2d Trust #10
Janis' 3d child JSK 3d Trust #10

JA-3 Trust Burton, Janis JSK 1st Trust #11
Evelyn Krakow & JSK 2d Trust #11
Janis' 3d child

JS-1 Trust Burton, Joshua JSK 3d Trust #13
Gerald L. Kanter & JSK 1st Trust #14
Joshua's 1st child

JS-2 Trust Burton, Joshua JSK 2d Trust #14
Ruth Kanter & JSK 3d Trust #14
Joshua's 2nd child

JS-3 Trust Burton, Joshua JSK 1st Trust #15
Joshua's 3d child JSK 2d Trust #15
& all of the children
of Gerald L. Kanter
living from time to time

BK Children's Burton, Naomi and JSK 1st Trust #1
Trust all of the children JSK 2d Trust #1
of Grantor's son JSK 3d Trust #1
living from time to time
 - 350 -

Original Additional
Trust Name Beneficiaries Beneficiaries

BK Descendant's Burton, Naomi and JSK 1st Trust #2
Trust all of the JSK 2d Trust #2
descendants of JSK 3d Trust #2
Grantor's son living
from time to time

BK Grand Children's Burton, Naomi and JSK 1st Trust #3
Trust Burton's Grand JSK 2d Trust #3
children living JSK 3d Trust #3
from time to time

Lillian Trust Burton, Naomi and JSK 2d Trust #20
Lillian Wilsker JSK 3d Trust #20

J-1 Wife's Trust Burton, Joel's JSK 1st Trust #6
Wife and the JSK 2d Trust #6
children of JSK 3d Trust #6
Carl I. Kanter living
from time to time

J-2 Husband's Trust Burton, Janis' JSK 1st Trust #7
husband and the JSK 2d Trust #7
children of JSK 3d Trust #7
Aloysius B. and
Helen M. Osowski

J-3 Wife's Trust Burton, Joshua's JSK 1st Trust #8
wife and Ruth & JSK 2d Trust #8
Philip Loshin JSK 3d Trust #8

Kanter was the trustee for all of the 60 additional trusts

which became the beneficiaries of the 25 trusts of BRT. No

evidence was introduced as to terms of, or the identity of the

beneficiaries of, the 60 additional trusts that became

beneficiaries of the 25 trusts of BRT.

The address of the original 25 trusts of BRT was Solomon A.

Weisgal, Trustee, C/O CMB & CO., P.O. Box 560068, Miami, FL

33156. The address for each of the 60 additional Trust
 - 351 -

beneficiaries was Burton W. Kanter, Trustee, P.O. Box 560068,

Miami, FL 33156.

During the entire existence of BRT, the named trustee has

been Weisgal. He has been a close friend and business associate

of Kanter for 30 years. He is a certified public accountant.

Weisgal has never had any beneficial interest in BRT.

The BRT agreement recites that the grantor, Bea Ritch,

contributed $100 to each of the 25 trusts. Kanter introduced no

evidence that the amount recited as having been contributed by

Bea Ritch was actually contributed by her. Kanter presented no

evidence of any other contributions by Bea Ritch.

Prior to 1987, Kanter borrowed money from BRT. As of

January 1, 1987, Kanter owed $287,030 to BRT. As of October 31,

1987, Kanter still owed $287,030 to BRT. As of January 1, 1989,

Kanter owed $1,311,430 to BRT. As of December 31, 1989, Kanter

owed $34,971 to BRT. The amount Kanter owed to BRT was not

repaid by Kanter, but his debt to BRT was transferred to Northern

Fin. Assoc. and Astor Holding Co. As of December 31, 1989,

Kanter owed $523,030 to North Fin. Assoc. and owed $750,000 to

Astor Holding Co.

Prior to 1987, Kanter also borrowed money from Holding Co.

As of January 1 and October 31, 1987, Kanter owed $300,000 to

Holding Co. As of January 1 and December 31, 1989, Kanter owed
 - 352 -

$500,841 and $549,841 to Holding Co., respectively. As of

December 31, 1989, Kanter owed $600,000 to IRA.

BRT contributed its interests in Ever Ritch Partners and

Broadway Properties to Northern Financial Corp. pursuant to a

section 351 transfer. Kanter acted as agent or nominee for BRT.

Respondent subpoenaed both Weisgal, as trustee of BRT, and

Kanter for the books and records of BRT. Other than tax returns

of BRT, neither Weisgal nor Kanter produced the documents

requested by the subpoenas.

In the early days of the law firm of Levenfeld and Kanter or

Levenfeld, Kanter, Baskes, and Lippitz (LK), Kanter began a

practice within LK that, to the extent there were "investment

opportunities", the partners of the law firm would be advised of

them and would be offered the opportunity to participate to the

extent of their then existent partnership interests in the law

firm. The partners could choose to participate on behalf of

themselves, their family members, extended family, and/or through

entities such as trusts, partnerships, or corporations for the

benefit of their family. Under this policy, if a partner did not

participate, his percentage was offered to the other partners.

In 1973, Charles F. Dolan (Dolan) was negotiating to

purchase franchises for cable television from Time, Inc. He had

met Kanter in the late 1960's. At the direction of Kanter, Roger

S. Baskes (Baskes) attended a meeting with Dolan and Time, Inc.
 - 353 -

Baskes was there for the purpose of explaining the process

involved in raising funds for the sale of limited partnerships.

From January of 1965 to May of 1978, Baskes was a partner in LK.

On September 1, 1973, LK formed a partnership known as

Oyster Bay Associates (OBA). The partners of OBA included

members of LK, or entities owned by themselves or members of

their families. Each LK partner or his family entity that became

a partner of OBA shared in the profits and losses of OBA in the

same percentage that such partner shared in the profits and

losses of LK. The partners of OBA contributed total capital to

OBA of $100,000. The partners of OBA received back distributions

in excess of their capital contributions during 1974.

Kanter chose to participate in OBA. He could have

participated personally in OBA but designated BRT to participate

in OBA up to his 18 percent interest in LK.

On the same day that OBA was formed, September 1, 1973, an

Illinois general partnership, Long Island Cable Communications

Development Co. (Long Island Cable), was formed. The partners of

Long Island Cable included "class A" partners and one "class B"

partner, OBA.

The Long Island Cable partnership agreement recited that the

purpose of Long Island Cable was to negotiate for the purchase of

certain existing franchise rights and equipment collectively

constituting a cable television system in Nassau County, New
 - 354 -

York, and thereafter to operate such franchise rights by the

construction of additional cable communication facilities and

marketing such facilities in New York or Illinois.

The class A partners, their percentage interests in Long

Island Cable, and their capital contributed were as follows:

Partner Percentage Capital Contributed
Charles F. Dolan 60 $100,000
Steven Miller 25 40,000
Peter Strauss 15 25,000
Total 100 165,000

The Long Island Cable partnership agreement provided that

the class B partner, OBA, agreed to contribute or secure

additional partners to contribute all additional cash required by

way of capital to advance the business of Long Island Cable.

The Long Island Cable partnership agreement provided that

the profits and losses of Long Island Cable were to be shared by

the class A Partners in their percentage capital 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 7/8 by the class A partners and 1/8 by the

class B partner, OBA.

On January 25, 1974, a New York limited partnership, also

called Long Island Cable Communications Development Co. (LICCDC)

was formed by and among Communications Development Long Island

Corp. a New York corporation (CDLIC), Communications Management
 - 355 -

Corp. a Delaware corporation (CMC), and Charles F. Dolan and

Limited Partners (Limited Partners).

All of the stock of CMC was owned by OBA. Kanter was the

president of CMC, and Baskes was the vice president of CMC.

The LICCDC partnership agreement provided that the purpose

of LICCDC was 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.

The Limited Partners of LICCDC included two classes, "class

A participants" and "class B participants". The class A

participants consisted of various persons that contributed cash

of $1,015,000 and $485,000 in 1974 and 1975, respectively.

The class B participants consisted of OBA and Eagle

Ventures, Inc. (EV). The LICCDC partnership agreement provided:

"Any additional cash required to complete the equity portion of

the 450 mile addition of the Oyster Bay system which cannot now

be borrowed by the Partnership shall be contributed half by the

General Partners and half by the class B Participants, provided,

however, that neither the General Partner nor the class B

Participants shall be required to make capital contributions

after June 30, 1976."

Article 6.4 of the LICCDC partnership agreement provided

that "payment from the General Partner or from the class B
 - 356 -

participants is due and payable within forty-five (45) days of

any call therefor by the General Partner". The general partner,

as defined in the agreement, included Dolan, CDLIC, and CMC, a

corporation owned by OBA.

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, 5.5 percent, 83.5

percent, and 11 percent by Dolan and CDLIC, the class A

Participants and the class B Participants, respectively; and 64

percent, 1 percent, 22.5 percent, and 12.5 percent by Dolan and

CDLIC, CMC, the class A Participants, and the class B

Participants, respectively after Payout or January 1, 1977,

whichever occurred later. Payout was defined to refer to the

date on which the aggregate cumulative cash-flow distributed to

the partners after the inception of the partnership equaled or

exceeded $1,500,000.

Class C and class D interests in LICCDC were created by

amendment to the LICCDC partnership agreement on January 1, 1975.

On the same day, Dolan and OBA formed the Hempstead Babylon

partnership to acquire the class C and class D interests. Within

10 days, on January 10, 1975, the C interests were sold to

Nassau/Suffolk Cablevision Investors for $4,500,000.
 - 357 -

In addition to providing legal services, Kanter's law firm,

LK, raised capital for investments from clients of the firm.

Kanter and other partners of LK that participated in OBA

solicited and obtained from various investors the funds that were

provided to LICCDC that had been purportedly promised to LICCDC

by OBA. Kanter and other partners of LK solicited and obtained

from various partners, as investors, the funds that were provided

to LICCDC that had been purportedly promised by OBA. As noted

earlier, BRT was an indirect partner in OBA through the HB, BW,

and YP partnerships. Kanter personally solicited investors for

LICCDC including, but not limited to, Genesis Ventures and Hugh

Hefner. As a result of the funds raised by Kanter and other

partners of LK for LICCDC, OBA never contributed cash or property

to LICCDC in excess of $200.

In exchange for the funds raised by Kanter and other

partners of LK for LICCDC, OBA received its interest in LICCDC

and additional interests in LICCDC through the partnerships HB,

BW, and YP for which OBA paid no cash or other property other

than $200.

By an amendment to its partnership agreement, as of June 13,

1978, LICCDC changed its name to Cablevision Systems Development

Co. (Cablevision).
 - 358 -

Kanter was the owner of the interests of BRT in LICCDC (or

Cablevision), including, but not limited to, BRT's interests in

OBA, HB, BW, and YP.

During the years 1981 to 1986, certain income that Kanter

earned was credited to BRT's capital account with Century

Industries. (See Century Industries Findings of Fact). Century

Industries distributed $4,900 to BRT in each of the years 1982,

1983, and 1984.

Kanter earned half the income distributed by Century

Industries to BRT. (See Century Industries Findings of Fact).

IRA, Holding Co., and Windy City were three of Kanter's sham

corporations used by Kanter to conceal and shift his income. BRT

was the sole shareholder of IRA and Windy City and was a

substantial shareholder of Holding Co.

Kanter assigned substantial amounts of his income to IRA and

Holding Co. Kanter transferred assets to Windy City for less

than adequate consideration, thereby increasing the value of

BRT's stock in Windy City. Kanter sold "notes receivable" or

stock to Windy City for nominal consideration and claimed a loss

on the transfer. The receivables, however, had value. The

transfers of stock and receivables increased the value of BRT's

stock in Windy City to the extent the value of the notes

receivable or stock exceeded the nominal consideration paid by

Windy City.
 - 359 -

OPINION

At the outset we reject Kanter's contention that respondent

had raised "new matter" on which respondent bore the burden of

proof in asserting that the income from the various partnerships

was Kanter's income in 1986 rather than 1987. A notice of

deficiency was issued to Kanter for 1986, and a petition was

filed. That year is before the Court. Therefore, a reallocation

of the partnerships' income between 1986 and 1987 is permissible

for the reasons stated in our findings of fact.

The pivotal question here is whether the Bea Ritch Trusts

should be recognized in 1986 and 1987 as separate taxable

entities, apart from Kanter, or whether Kanter should be treated

as the true owner of the trusts and thus taxable on BRT's income

for those years.

Kanter contends that the Bea Ritch Trusts were valid grantor

trusts that correctly reported income, deductions, and losses in

1986 and 1987. He asserts that his mother, not himself, was both

the nominal and true grantor of BRT, and that Weisgal, as

trustee, made the decisions to invest or not to invest for the

trusts. To the contrary, respondent contends that Kanter was the

true owner of the Bea Ritch Trusts, and the trusts' income for

1986 and 1987 is taxable to him.

We agree with respondent. Although a trust may be valid

under State law, the trust will not necessarily be recognized for
 - 360 -

tax purposes. See Furman v. Commissioner, 45 T.C. 360, 364

(1966). Trusts lacking in economic substance created to avoid

taxes have been disregarded by the Court. See Zmuda v.

Commissioner, 79 T.C. 714 (1982); Markosian v. Commissioner, 73

T.C. 1235 (1980); Furman v. Commissioner, supra at 366; Sandvall

v. Commissioner, T.C. Memo. 1989-189.

In considering and weighing the facts with respect to this

issue, we note that the principle of substance over form is

peculiarly applicable to trusts because they are easily

manipulated so as to create illusion. See Lazarus v.

Commissioner, 58 T.C. 854, 864 (1972), affd. 513 F.2d 824 (9th

Cir. 1975), where we stated (citing Helvering v. Clifford, 309

U.S. 331, 334 (1940)): "Technical considerations, niceties of

the law of trusts or conveyances, or the legal paraphernalia

which inventive genius may construct must not frustrate an

examination of the facts in the light of the economic realities."

While the named grantor of BRT was Kanter's mother, the

evidence shows that Kanter funded all or substantially all of BRT

by assigning his earned income or assets earned by his personal

services to BRT. In this manner, Kanter attempted to circumvent

the progressive rate structure of the Federal income tax system

and eliminate or substantially reduce his income tax by diverting

his income to 25 trusts (eventually 85) for the benefit of his

family. At the same time he attempted to transfer his personal
 - 361 -

service income or assets earned by his personal services out of

his estate to BRT, thereby avoiding potential gift and estate

taxes.

The evidence shows that Kanter funded all or a substantial

portion of BRT. Kanter and his law partners acquired interests

in Cablevision by soliciting investors to finance the purchase of

franchise rights and to finance the construction and expansion of

the cable system. Kanter funded BRT by transferring those

partnership interests to BRT for no consideration. He earned

income for providing investment counseling services that he

credited to the Century Industries capital account of BRT,

thereby funding BRT's interest in Century Industries as well as

funding the income distributions from Century Industries to BRT.

He funded BRT's stock interests in IRA and Holding Co. by

assigning his personal service income to those entities. He also

funded BRT's stock interest in Windy City by transferring assets

to Windy City for less than adequate consideration.

Section 671 provides that the grantor is taxable on the

income attributable to any portion of the trusts for which he is

treated as the owner under subpart E of the Code. The grantor is

not necessarily the grantor named in the trust instrument. For

income tax purposes, the grantor may be the person who funds the

trust. Bixby v. Commissioner, 58 T.C. 757, 791 (1972). This

Court has held that the true grantor is not the one named in the
 - 362 -

trust instrument where the named grantor made only nominal

contributions, another person funds the trust and the named

beneficiaries reflect the true grantor's (the person who funds

the trust) desires as to lifetime and testamentary dispositions

of their property. In such case, the nominal contributions of

the named grantor are disregarded, and the person who funded the

trust is treated as the true grantor. Bixby v. Commissioner,

supra; Smith v. Commissioner, 56 T.C. 263, 290 (1971).

Kanter failed to establish that he did not fund BRT. Other

than the BRT agreement, which recites that Bea Ritch, Kanter's

mother, contributed $100 to each of the 25 trusts, Kanter

introduced no evidence (such as canceled checks, balance sheets,

or other books and records of BRT) to substantiate that Ritch

actually contributed to BRT the amounts recited in the agreement

or that she made any other contributions to BRT. Despite the

fact that respondent subpoenaed both Weisgal, the named trustee

of BRT, and Kanter for the books and records of BRT, with the

exception of tax returns and certain records related to BRT's

interest in Cablevision, the books and records of BRT were not

produced. The inference we draw from this is that if the records

had been produced and introduced into evidence, they would have

revealed evidence unfavorable to Kanter; namely, that he made

substantial contributions directly or indirectly to BRT.
 - 363 -

In any event, Kanter failed to prove that he was not the

true grantor of BRT in 1986 and 1987. As indicated by the 1987,

1988, and 1989 BRT returns and other evidence, BRT had

substantial assets that generated millions of dollars of gross

income. These assets were not generated solely from the $2,500

allegedly contributed by Ritch at the inception of BRT. Rather,

the evidence shows that Kanter funded BRT with his personal

service income or assets earned by his personal services.

We think Kanter, not the named trustee, Weisgal, controlled

the administration of the Bea Ritch Trusts. Weisgal was an

officer of convenience for various Kanter-related entities. He

signed transactional documents without knowledge of the

underlying transactions. In our view, Weisgal was also a trustee

of convenience with respect to BRT. He was not an independent

trustee but was subservient to the wishes, control, and

domination of Kanter.

Although Weisgal testified that Kanter did not have the

final say on investments of BRT, the fact that BRT primarily

invested in entities, such as OBA, Century Industries, Holding

Co., IRA, and Windy City, which enabled Kanter to assign his

income or assets for the benefit of BRT, shows that Kanter did

more than recommend investments.

Furthermore, IRA and Holding Co. (and their subsidiaries)

distributed millions of dollars of their funds to various
 - 364 -

entities and individuals that were recorded as loans receivable.

There were never any notes evidencing the loans, the loans were

never secured, and substantial amounts were written off as

worthless. We do not think that an independent trustee would

have permitted corporations in which the trust was either the

sole shareholder or the majority shareholder to have made such

"loans". A truly independent trustee of a valid trust (who often

also served as an officer or director of the corporations) could

not permit such transactions without breaching his fiduciary

duties to the trust and the corporations. If Weisgal had been

an independent trustee, we do not think that he would have risked

being held liable for such breach. The "loans" were made and

written off as part of Kanter's income diversion and laundering

scheme at Kanter’s behest. The corporations and trusts merely

served as part of the scheme.

Kanter's control over the administration of BRT is also

shown by the fact that BRT was a client of Administration Co.,

Administrative Enterprises, and Principal Services, which were

all entities controlled by Kanter.

Weisgal did not maintain the books and records of BRT. They

were maintained by Kanter, Administration Co., Administrative

Enterprises, or Principal Services. When respondent served a

subpoena on Weisgal for the books and records of BRT, no records

were produced. Although he was the named BRT trustee, Weisgal
 - 365 -

did not know who possessed the books and records. When

respondent served a subpoena on Kanter for records of BRT, Kanter

produced various tax returns but did not produce requested

records related to the basis of assets. Weisgal testified that

he had a 3-year retention policy except that records related to

basis were kept until the applicable asset was sold. However,

neither Kanter nor Weisgal produced records related to basis that

were sought by respondent even though, under Weisgal's stated

policy, such records should have been available. The fact that

Weisgal did not maintain the books and records of BRT and the

fact that Kanter, rather than Weisgal, produced records is also

indicative of Kanter's control over BRT.

Kanter received loans from BRT. He owed $287,030 and

$1,311,430 to BRT in 1987 and 1989, respectively. Kanter did not

establish that these loans were for adequate consideration, that

the loans were adequately secured or that the loans were ever

repaid. He also indirectly borrowed money from BRT by borrowing

money from IRA and Holding Co., the stock of which corporations

was in whole or in part owned by BRT.

Section 674(a) provides that the grantor of a trust will be

treated as the owner of any portion of the trust whose income,

without the approval of an adverse party, is subject to a power

of disposition, exercisable by the grantor or a nonadverse party,

or both, without the approval or consent of any adverse party.
 - 366 -

Section 674(b) provides that subsection (a) does not apply to

certain powers. A power held by any person to add to the

beneficiaries or to a class of beneficiaries designated to

receive the income or corpus, except where such action is to

provide for after-born or after-adopted children, does not fall

within the powers excepted from the application of section

674(a). Section 672 provides that an adverse party is a party

that has a substantial beneficial interest that could be

adversely affected by the exercise or nonexercise of a power he

possesses respecting the trust.

Section 1.674(a)-1, Income Tax Regs., defines the scope of

the power of disposition which will require taxation of trust

income to the grantor. In general a power that can affect

beneficial enjoyment of a trust or a portion of a trust is a

power to dispose of the beneficial enjoyment, even if it is held

in a fiduciary capacity. Section 1.674(a)-1(a), Income Tax

Regs., provides:

Under section 674, the grantor is treated as the
owner of a portion of a trust if the grantor or a
nonadverse party has a power, beyond specified limits,
to dispose of the beneficial enjoyment of the income or
corpus, whether the power is a fiduciary power, a power
of appointment, or any other power.

Section 3.2 of article III of the trust agreement gives Kanter a

power of appointment over all but one of the original trusts.

That power could be exercised during his lifetime or as a

testamentary power.
 - 367 -

The BRT originally consisted of 25 trusts, the beneficiaries

of which were all individuals. Most of the beneficiaries of BRT

were members of Kanter's family. As shown by the BRT agreement,

Kanter's 1978 renunciation, and the Forms K-1 attached to the

1988, 1987, and 1988 BRT returns, sometime after Kanter

purportedly renounced his interest in BRT and during or before

1987, 60 new trust beneficiaries (the JSK trusts) were added to

the 25 trusts of BRT. Although Kanter purportedly renounced his

interest in BRT in 1978, including his power of appointment, he

nonetheless added 60 new trust beneficiaries to BRT. According

to the BRT agreement, only Kanter, through exercise of his power

of appointment, could have created these new trust beneficiaries.

Because the power of appointment vested in him the power to add

new beneficiaries other than after-born children, the power of

appointment was a power of disposition. See sec. 1.674(a)-1,

Income Tax Regs. Because we regard Kanter as the true grantor,

his possession of the power of appointment (a power of

disposition) makes the trust income taxable to him in 1986 and

1987.

Weisgal, the named trustee, had no beneficial interest in

BRT. Since Weisgal had no beneficial interest in BRT, he is a

nonadverse party. See sec. 672. Thus, even if the 60 new trust

beneficiaries were added pursuant to a power held by Weisgal, a
 - 368 -

nonadverse trustee, Kanter, as the true grantor, would also be

taxable on the income of BRT.

We think Kanter failed to establish that he was not the true

grantor of BRT in 1986 and 1987. Because of this and his failure

to establish that the beneficial enjoyment of any portion of BRT

was not subject to a power of disposition, within the meaning of

section 674, we agree with respondent that he should be treated

as the owner of BRT and taxable on the income of the trusts in

those years. See Schulz v. Commissioner, 686 F.2d 490 (7th Cir.

1982).

Moreover, under section 3.1 of the trust agreement, Weisgal,

a nonadverse trustee, had the power to distribute the income or

principal among the trust beneficiaries as he deemed in their

best interests. The power to dispose of income is the equivalent

of ownership of it. The power to allocate income among trust

beneficiaries is a power of disposition over beneficial

enjoyment. The power to determine which beneficiary will receive

trust income is the power to affect beneficial enjoyment. A

power exercisable by the grantor or by a nonadverse party to vary

or "sprinkle" income between beneficiaries will result in

taxation of the trust income to the grantor unless one of the

exceptions provided in section 674(b), (c), or (d) applies.

Section 675(3) provides that the grantor is treated as the

owner of any portion of a trust in respect of which the grantor
 - 369 -

has directly or indirectly borrowed the corpus or income of the

trust and has not completely repaid the loan, including any

interest, before the beginning of the taxable year. However,

this section does not apply to a loan which provides for adequate

interest and adequate security if such loan is made by a trustee

other than the grantor and other than a related or subordinate

trustee subservient to the grantor.

Prior to 1987, Kanter borrowed money from BRT. As of

January 1, 1987, he owed $287,030 to BRT. As of October 21,

1987, he still owed $287,030 to BRT. As of January 1, 1989, he

owed $1,311,430 to BRT. Kanter introduced no evidence that this

loan provided for adequate interest and adequate security.

Because we conclude that Kanter was the true grantor of BRT

and that sections 674 and 675(3) apply, we hold that he is

taxable on the income of the trusts in 1986 and 1987. To the

extent that the income, set forth in the notice of deficiency for

1987, was earned by partnerships in 1986, such income is taxable

to Kanter for 1986. With respect to the years involved in this

issue which coincide with or involve the same year or years that

are involved with Century Industries (Issue 2), to the extent

certain payments to Century Industries have been determined to

constitute Kanter's income, such income should not be considered

in determining BRT's allocable share of income as a partner in
 - 370 -

Century Industries to avoid the double inclusion of such income

to Kanter.

Issue 5. Whether Kanter Had Unreported Income for 1982, 1983,
1984, 1987, 1988, and 1989 From the CMS Investors Partnership

FINDINGS OF FACT

Certain "bonus payments" were made by two partnerships,

Shelburne and Century, to Delta and Alpha Partnerships. CMS

Investors, a partnership, was a partner in both Delta and Alpha

partnerships, and, therefore, CMS Investors received from Delta

and Alpha the distributable share of the bonus payments that

originated from Shelburne and Century. Holding Co. was one of

the partners in CMS Investors, and Holding Co. received its

distributable share of these bonus payments as a partner in CMS

Investors. Holding Co. reported these payments as income on its

Federal income tax returns.

In notices of deficiency, respondent determined that Kanter

failed to report income earned by him in the amounts of $191,461,

$232,900, $290,785, $29,998, $127,249, and $279,596 for the years

1982, 1983, 1984, 1987, 1988, and 1989, respectively, that was

reported by Holding Co. as its share of the ordinary income of

the CMS Investors partnership.

OPINION

This Court, in Durkin v. Commissioner, 87 T.C. 1329 (1986),

affd. 872 F.2d 1271 (7th Cir. 1989), made certain factual

conclusions regarding the loan by Delta to Shelburne and the loan
 - 371 -

by Alpha to Century under which loans these bonus payments were

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 the bonus

payments as interest and claimed deductions of such payments for

income tax purposes. In Durkin v. Commissioner, supra, this

Court held that the bonus payments did not constitute

compensation for the use of money and, therefore, were not

deductible as interest. We further found that the bonus payments

essentially were nothing more than a "mechanism" to divert funds

from Shelburne and Century to the partnerships, "thereby

increasing the income of the partnership and trust associated

with or established for the benefit of the members of the law

firm or their immediate families." Id. at 1400. Our holding

that the bonus payments were not deductible as interest was

affirmed by the Seventh Circuit. See Durkin v. Commissioner, 872

F.2d at 1278-1279.

The parties here do not dispute the factual findings or the

holding in Durkin v. Commissioner, supra. Nor do they deny that

the bonus payments constitute income to the recipient

partnerships. Respondent, however, on the basis of the language
 - 372 -

of the Court in Durkin that the bonus payments were used by

Shelburne and Century as a mechanism to divert funds "for the

benefit of the members of the law firm or their immediate

families", determined that Kanter realized income from these

bonus payments as a member of the law firm of Levenfeld and

Kanter.

On brief, respondent acknowledges that Durkin did not

address the question of whether the family entities or the LK

partners (the partners of the Levenfeld and Kanter law firm),

individually, were taxable on the bonus payments paid by

Shelburne to Delta. Respondent, nevertheless, argues that Kanter

is taxable on his share of the bonus payments paid by Shelburne

and Century to Alpha and Delta. As noted earlier, CMS Investors

was a partner in Alpha and Delta. Respondent determined that

Kanter, and not Holding Co., was the partner in CMS Investors,

and, accordingly, the bonus payments that were allocable to

Holding Co. as a partner in CMS Investors were, instead,

allocable to Kanter individually.

Kanter contends that this Court lacks subject matter

jurisdiction because the Levenfeld and Kanter law firm was a

TEFRA partnership during each of the years at issue, and, in

fact, respondent issued an FPAA to the law partnership, which

included the subject adjustment for the year 1994. He also

contends that respondent is collaterally estopped from
 - 373 -

attributing the income at issue to him by virtue of the opinion

in Durkin v. Commissioner, supra. Finally, he contends that the

loans, upon which the bonus payments were made, constituted

income to the partnership that made the loans, and, therefore,

such income from the bonus payments should be attributable to the

partnerships involved, Delta and Alpha, and would flow through to

CMS Investors, in which latter partnership Holding Co. was a

partner, and that he was never a partner in either CMS Investors,

Delta, or Alpha.

Respondent argues that, with respect to the bonus payments

flowing through to CMS Investors, such income was earned

individually by Kanter and not by Holding Co. under the

assignment of income principle. See Lucas v. Earl, 281 U.S. 111

(1930). Respondent argues that the loans by Delta and Alpha were

not by these entities, and, therefore, Delta and Alpha were not

the "trees" that bore the fruit; i.e., the bonus payments.

Respondent appears to base this contention on the Court's finding

in Durkin v. Commissioner, supra, that the bonus payments were

not made for the "use" of money but were used as a mechanism to

divert funds to the various entities that were "established for

the benefit of the LK partners and/or their immediate families".

Respondent further contends that 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 have
 - 374 -

alleviated the need for such financing. Consequently, respondent

argues that the loans were structured to create purported

payments of interest which were, in effect, payments to Kanter

and his law firm for legal services the Levenfeld and Kanter law

firm provided in connection with the movie syndications.

On brief, respondent argued:

Under the practice of LK (Levenfeld/Kanter) that
was established by Kanter, the opportunity to
participate in Delta and Alpha through CMS was offered
solely to the partners of LK to the extent of their
then existent partnership interests. In the case of
CMS, none of the LK partners took their interest
individually, but instead designated various entities
for the benefit of their families to take interest in
CMS that they themselves were otherwise entitled to.
Kanter made the decision to participate in CMS.
Although Kanter could have taken his interest in CMS
individually, Kanter directed that THC [Holding Co.]
take his interest in CMS.

Respondent further points out that the purpose of diverting

the bonus payments to CMS Investors, which flowed through to

Holding Co. and other entities, was the "improper avoidance of

income, gift and estate taxes" because Holding Co. had large

operating losses and, therefore, paid no income taxes on the

bonus payments received. It is also argued that, with respect to

all of the partners in Levenfeld and Kanter who participated in

the investment, 147 trusts were used as partners in CMS, all of

which, for one reason or another, avoided taxes the partners

individually would have been required to pay.
 - 375 -

I. Subject Matter Jurisdiction This Court has jurisdiction to

determine its own jurisdiction. See Normac, Inc. v.

Commissioner, 90 T.C. 142, 146 (1988). The jurisdictional

question presented here turns on whether the bonus payments, in

fact, were income of Kanter's law firm partnership.

Kanter and his law partner, Calvin Eisenberg, testified

that, pursuant to a longstanding practice existing at their law

firm, investments in Delta and Alpha were voluntary and were made

by a law firm member, a member's immediate family, and/or the

members' entities on an entirely non-law-firm-partnership basis.

They stated that not all of the law firm members participated in

Delta and Alpha. They further stated that the law firm

partnership did not have any interest or rights to the income

Delta and Alpha would earn from their respective loans to

Shelburne and Century.

Delta's and Alpha's respective interim loans to Shelburne

and Century were not investment activities of Kanter's law firm

partnership. The law firm members who participated in these

ventures had no intention to invest on their law firm's behalf.

More importantly, the alleged diversions of funds from Shelburne

and Century were not joint business endeavors of the law firm

partnership's partners, as only those members of the law firm

and/or their families who invested in Delta and Alpha would

benefit from the "bonus payments". We conclude that the "bonus"
 - 376 -

funds allegedly diverted to Delta and Alpha were not income of

Kanter's law firm partnership. As a result, we further conclude

that we have subject matter jurisdiction over the CMS Investors

income adjustments at issue here because the adjustments are not

partnership items of a TEFRA partnership. We therefore reject

Kanter's contention that the Court lacks subject matter

jurisdiction over this issue.

The Court finds that it is not necessary to address Kanter's

claim that respondent is collaterally estopped as to this issue

by virtue of Durkin v. Commissioner, 87 T.C. 1329 (1986).

II. Whether the CMS Income Constitutes Kanter's Income

The Shelburne and Century movie partnerships made "bonus

payments" to Delta and Alpha pursuant to interim loans that had

been made by Delta to Shelburne and by Alpha to Century.

Respondent does not dispute that, under these loan arrangements,

Delta and Alpha lent millions of dollars that this Court, in

Durkin, stated were debts recognizable for tax purposes. Rather,

respondent contends that the portion of these "bonus payments"

otherwise allocable to Holding Co. is taxable income to Kanter

because he and other members of his law firm were the true

investors and the true lenders. The Court rejects that argument.

Respondent goes well beyond the holding of Durkin v.

Commissioner, supra. Based on the Court's statement in Durkin

that the bonus payments were a "diversion" of funds for the
 - 377 -

benefit of the Levenfeld and Kanter law firm, respondent asserts

that the loans giving rise to the bonus payments were, in effect,

loans made by Kanter and his law partners. The Court, in Durkin,

made no such finding and, moreover, that was not a question for

us to decide in that case. In Durkin, the Court held that the

bonus payments did not constitute interest and, therefore, were

not deductible. The bonus payments were in the amount of 10

percent of the borrowers’ worldwide nontheatrical gross receipts.

They were not "compensation for the use or forbearance of money".

The bonus payments were not deductible because they were

distributions of profits disguised as interest. Distributions of

profits are not deductible. To conclude from such holding that

the loans were made by Kanter and his law firm partners (and not

Holding Co. and the other partners in CMS Investors) is a

misinterpretation of Durkin. Similarly, the payments were not

made for Kanter's services. If they had been, they would have

been deductible. There is no evidence to support respondent's

contention, as to this issue, that the true party at interest was

Kanter and not Holding Co. Therefore, we sustain Kanter on this

issue.

Issue 6. Whether Kanter had Unreported Income in 1983 From
Equitable Leasing Co., Inc.

FINDINGS OF FACT

In the notice of deficiency issued to the Kanters for 1983,

respondent determined that Kanter did not report income of
 - 378 -

$635,250 from Equitable Leasing Co., Inc. (Equitable Leasing).

The notice stated that the income "represents fee income which

was assigned to a related entity or the true nature otherwise

disguised".

Equitable Leasing made the following payments to Holding Co.

and Zion, a subsidiary of Holding Co.:

Form of
Date Payment Payee Amount

1-8-83 Bank transfer Zion $317,250
1-24-83 Check Holding Co. 9,500
6-1-83 Check Zion 6,500
6-30-83 Bank transfer Holding Co. 302,000
Total 635,250

The check dated January 24, 1983, to Holding Co. bore the

notation "commission". Holding Co.'s adjusting journal entries

identify the bank transfer of January 8, 1983, to Zion as

"commission income" for "commiss. from Eq Leasing". The record

does not show what the other two payments were for.

Equitable Leasing was the wholly owned company of Joel

Mallin (Mallin), who was a tax attorney, a former partner, and a

friend of Kanter. He was engaged in the business of selling and

promoting equipment leasing deals.

Kanter introduced investors to Mallin so that Mallin could

complete or close certain transactions. Kanter permitted Mallin

to use Zion as an investor and to make payments to Zion or

Holding Co.
 - 379 -

The transfers of funds by Equitable Leasing to Holding Co.

and Zion were not done as an accommodation to Equitable Leasing

to allow Equitable Leasing to complete investment offerings and

to close transactions in compliance with Federal and State

securities laws.

OPINION

Kanter has the burden of proving that he did not receive

commission or fee income from Equitable Leasing in 1983 as

determined by respondent in the notice of deficiency. He has

failed to do so. We conclude that the funds paid by Equitable

Leasing to Holding Co. and Zion in 1983 were generated by

Kanter's activity in providing investors. That these funds were

paid for services personally rendered by Kanter is supported by

Mallin's testimony that he paid Kanter through Equitable Leasing

commission fees to find investors for his deals. The earned

income was simply directed by Kanter to be paid by Equitable

Leasing to Holding Co. and Zion, both being Kanter's controlled

entities. Such anticipatory assignments of income were

ineffective to divest Kanter of income he earned in the

transactions.

We reject Kanter's uncorroborated, self-serving testimony

that Holding Co. and Zion were only providing an "accommodation"

to Equitable Leasing by accepting the funds in question.
 - 380 -

It is noted that the arrangements pertaining to Equitable

Leasing are similar to Kanter's method of operations for many

other investments involved in these cases, such as Prudential and

Century Industries. Payments were made to different affiliated

entities of Kanter. Often the records were confusing. However,

the only individual performing substantial services was Kanter.

Accounting records sometimes showed that another entity reported

the transaction for tax purposes. In other instances, accounting

records were destroyed, purportedly pursuant to a 3-year records

destruction policy. The records destruction policy was an

intentional means of preventing detection of Kanter's planning

devices. There was frequently a lack of supporting documentation

which we think must be held against Kanter and in favor of

respondent. This is especially true in view of Kanter's

background, training, experience, knowledge, and his failure to

explain the accounting for the services he rendered.

Accordingly, we sustain respondent's determination on this

issue.

Issue 7. Whether Kanter Had Unreported Income in 1982 Based on
the Bank Deposit Analysis Method

FINDINGS OF FACT

In the notice of deficiency for 1982, respondent determined

that $2,800,410 in deposits to Kanter's financial accounts with

American National Bank of Chicago during 1982 constituted

unreported gross income for the reason that Kanter did not
 - 381 -

maintain and did not provide books and records that would explain

the nature of these deposits. On brief, respondent conceded a

portion of the adjustment, but maintained that $1,303,207,

identified by payor or source in the following table, constituted

unreported gross income:

Payor or Source Deposit Amount
Holding Co. $787,129.17
Computer Placement Services 40,000.00
Administration Co. Special E 190,077.83
Administration Co. Special 286,000.00
Total 1,303,207.00

Other than notations in his check register that these

deposits were loan proceeds, Kanter provided no documentation

such as promissory notes or evidence of repayments of loans to

support his contention. Kanter's accountant, Gallenberger,

provided no corroborating testimony to show that the deposits in

question constituted loans or that the loans were ever repaid.

OPINION

Where a taxpayer fails to maintain or produce adequate books

and records, the Commissioner is authorized under section 446 to

compute the taxpayer's taxable income by any method which, in the

Commissioner's opinion, clearly reflects income. See Holland v.

United States, 348 U.S. 121, 130-132 (1954); Meneguzzo v.

Commissioner, 43 T.C. 824, 831 (1965); Sutherland v.

Commissioner, 32 T.C. 862 (1959). The Commissioner has latitude

in selecting a method for reconstructing a taxpayer's income, and
 - 382 -

the method need only be reasonable in light of all the

surrounding circumstances.

This Court has long accepted the bank deposits method of

income reconstruction. See 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.

See Boyett v. Commissioner, 204 F.2d 205 (5th Cir. 1953), affg.

T.C. Memo. 1951-67; Hague Estate v. Commissioner, 132 F.2d 775

(2d Cir. 1943), affg. 45 B.T.A. 104 (1941).

Kanter contends that respondent's determination and

reconstruction of his 1982 income under the bank deposits method

was arbitrary and excessive. He claims that he maintained

adequate records (i.e., his check register) identifying the

taxable and nontaxable deposits to his bank accounts. He argues

that respondent's determination should not be accorded its normal

presumption of correctness, and that respondent should either (1)

have the burden of proving that he, in fact, had taxable

deposits, or (2) have the burden of going forward with the

evidence.

Respondent, on the other hand, contends that Kanter did not

meet his burden of proof in establishing that the disputed

deposits had a nontaxable source. Respondent argues that the

evidence Kanter offered is insufficient. Besides the check
 - 383 -

register, respondent asserts, Kanter offered no other

documentation showing the nontaxable nature of the $1,303,207 of

the deposits at issue. Respondent notes that a substantial

portion of the disputed deposits was attributable to funds Kanter

received from the Administration Co. accounts which were

controlled by him.

We agree with respondent. Unlike Weimerskirch v.

Commissioner, 596 F.2d 358 (9th Cir. 1979), respondent here

provided direct evidence linking Kanter to an income producing

activity. This was not a naked determination. Kanter engaged in

many activities and received significant remunerations. Unlike

Weimerskirch, there are uncontradicted deposits to Kanter's bank

account. It was Kanter's burden to prove that the deposits did

not constitute income. It was he who had to show the true nature

of the deposits. He failed to do so.

Moreover, we view Kanter's conduct on this issue in the

context of all of his business and financial dealings, as

portrayed in these cases. The accounting for the transactions

was done by the same accounting entity (Administration Co.) that

provided services for the controlled Kanter entities.

Respondent's bank deposits determination clearly comports

with the opinion in United States v. Esser, 520 F.2d 213, 217

(7th Cir. 1975). In Esser, the Court of Appeals stated that the

Government has the burden of proving that the taxpayer was (1)
 - 384 -

engaged in an income-producing business, and (2) that regular

deposits of funds having the appearance of income were made to

bank accounts during the course of business. After the

Government has made this showing and given the taxpayer credit in

the income computation for any clearly identified nontaxable

sources, the taxpayer has the burden to explain "as far as

possible" the nature of the deposits.

No credible evidence was introduced to support Kanter's

assertion that the deposits were loans. The bank deposit slips

did not indicate the source and nature of the payments. Although

Kanter produced a summary analysis regarding the deposits and his

check register containing notations that certain deposits were

loans, the underlying documents pertaining to the purported loans

were not provided. No promissory notes and no journals or

ledgers with respect to interest payments are extant. Kanter's

self-serving testimony is not persuasive in view of the dubious

accounting techniques used by Administration Co. and Kanter's

failure to produce the necessary documents to establish that

there were loans. We find the testimony of the accountant,

Gallenberger, unreliable and her analysis fatally flawed because

she did not rely on the source documents for the purported loans.

She did not review the records of any entities to or by which the

purported loans were made. Moreover, the use of schedules and a

summary analysis prepared for trial further lacked credibility in
 - 385 -

light of Gallenberger’s regular practice of record destruction,

and the failure to respond to summonses issued by respondent.

See United States v. Administrative Enterprises, Inc., 46 F.3d

670 (7th Cir. 1995).

As to the funds Kanter received from Computer Placement

Services, one of the sources listed above, Mallin testified that

Kanter consulted with him and his company and Kanter was paid for

those services. Kanter's summary analysis relating to his

purported repayment of a loan from Computer Placement Services is

not supported by any underlying documentation.

Likewise, there is no convincing evidence that the funds

received by Kanter from the Administration Co. accounts were

loans. Again there is insufficient underlying documentation.

Accordingly, we hold that Kanter failed to prove that the

deposits in question were from nontaxable sources. Thus we

sustain respondent on this issue.

Issue 8. Whether Kanter Received Barter Income From Principal
Services in 1988 and 1989

FINDINGS OF FACT

In a notice of deficiency, respondent determined that Kanter

received and failed to report barter income from Principal

Services of $453,656 in 1988 and $581,530 in 1989. This

determination was made "in order to protect the revenue". There

was little or no evidence to support the determination at the

time the deficiency notice was issued. The determination was
 - 386 -

made as a protective measure "just in case" the agent

subsequently discovered evidence to support it.

Principal Services provided administrative and accounting

services to clients of Administrative Co. following

Administration Co.'s financial difficulties and bankruptcy in

February 1988.

Sometime in 1987, prior to Administration Co.'s filing for

bankruptcy, Administration Co. transferred to Principal Services

(which at that time had the name Administrative Enterprises)

funds held in Administration Co.'s accounts, which contained

funds of its clients. Principal Services then established

accounts similar to the Administration Co. special E and special

accounts. The funds held in these accounts were considered to be

owned by clients of Principal Services.

Kanter performed minimal legal services for Principal

Services in 1988 and 1989. He did represent Principal Services

in litigation before this Court, but that did not begin until

1991. There is no proof that the funds constituted barter income

to Kanter in 1988 and 1989.

OPINION

Kanter contends that he received no barter income from

Principal Services during 1988 and 1989. He asserts that he did

not render any substantial services to Principal Services in

those years and did not receive income from Principal Services.
 - 387 -

To the contrary, respondent argues that Kanter received barter

income from Principal Services's payments of expenses out of

Kanter's special accounts because the expenses were paid in

exchange for substantial legal services performed for Principal

Services.

We agree with Kanter on this issue. There is no proof that

he realized barter income from Principal Services. Any legal

services performed by Kanter for Principal Services in 1988 and

1989 were minimal at best. Respondent's determination with

respect to this income adjustment was erroneous on its face and

lacking in a rational evidentiary foundation. Respondent offered

no evidence to support this income adjustment but relied on the

presumption of correctness of the deficiency notice. We reject

respondent's position and hold that Kanter did not realize barter

income from Principal Services during 1988 and 1989.

Issue 9. Whether the Kanters Are Entitled to Certain Deductions
Claimed on Schedule A and Schedule C for 1986 Through 1989

FINDINGS OF FACT

For 1986, 1987, 1988, and 1989, almost all of the expenses

claimed on Schedules A and C of the Kanters' Federal income tax

returns were paid through funds from the Administration Co.

special E, Administration Co. special, Principal Services special

E, and Principal Services special accounts, which funds belonged

to Kanter.
 - 388 -

During those years the Kanters' personal residence was

titled in the Egondale Trust, a grantor trust of Kanter. Through

the Egondale Trust, Kanter paid the home mortgage interest and

real estate taxes on the personal residence, using funds from his

Administration Co. special E and the Principal Services special

accounts.

On Schedule A of the Kanters' 1986 Federal income tax

return, a deduction of $368,227 was claimed for other interest

expenses.

On the Schedules A and the Schedules C of their respective

1987, 1988, and 1989 Federal income tax returns, the following

deductions were claimed:

Schedule A 1987 1988 1989

Charitable contributions -- $61,555 $23,747
Home mortgage interest $123,936 135,596 173,587
Investment interest 6,500 170,993 309,880
Medical expenses -- 994 --
Miscellaneous expenses 7,805 36,837 30,378
Real estate taxes 53,031 66,646 57,384
State & local income taxes -- 29 1
Total 191,272 472,650 594,977

Schedule C 1987 1988 1989

Bank charges -- -- $48
Dues & publication expenses -- $2,328 2,878
Legal & professional expenses $44,476 -- --
Office expenses -- 26,892 --
Utility & telephone expenses -- 4,252 3,343
Total 44,476 33,472 6,269

In the notice of deficiency for 1986, respondent determined

that no deduction was allowable to Kanter for the $368,227
 - 389 -

claimed interest expense. The notice stated, in part, as

follows:

It is determined that the claimed interest expense
deduction of $368,227 in 1986 is not allowed because
you have not established:

(1) that there was a valid indebtedness;

(2) if there was a valid indebtedness, that the
indebtedness was yours; or

(3) that you actually paid any interest.

During the course of the trial, petitioners began offering

evidence with respect to the claimed deductions and expenses.

Counsel for the parties then requested and received a recess in

order to meet and discuss off the record the various evidentiary

and legal matters pertaining to the deductions and expenses. The

Court did not participate in counsel's deliberations.

Immediately following their conference, counsel for the

parties advised the Court on the record that the Schedule A and

Schedule C claimed deductions and expenses had been

substantiated, except that respondent disputed that the expenses

paid out of funds from the Administration Co. and Principal

Services accounts had been paid by Kanter and questioned whether

the Kanters were entitled to deduct expenses with respect to

property held in trust. Counsel did not specifically mention

whether their agreement included the 1986 interest deduction.

However, counsel for petitioners expressed to the Court their

belief that the parties had narrowed the issues on all of the
 - 390 -

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 Administration Co. special E

and Principal Services special accounts represented payment by

Kanter, and (2) whether the Kanters were entitled to a deduction

for mortgage interest payments made with respect to property (the

Kanters' personal residence) that was titled in a grantor trust

of which Kanter was the deemed owner.

Respondent also conceded that Kanter's Schedule C expenses

were ordinary and necessary to his business.

The Kanters claimed that the Schedule A and Schedule C

deductions and expenses disallowed by respondent for the years

1986 through 1989 were paid with Kanter's funds.

The Kanters are entitled to mortgage interest and real

estate taxes paid on their personal residence titled in Egondale

Trust, which was Kanter's grantor trust.

OPINION

On brief, respondent attempted to retract oral stipulations

made on the record that, for purposes of deciding respondent's

disallowed Schedule A and C deductions and expenses for the years

involved, this Court need only decide whether the funds used to
 - 391 -

pay them were paid by or on behalf of Kanter. We reject

respondent's attempt to raise additional grounds for

disallowance. Unfortunately for respondent, any additional

grounds were abandoned by the oral stipulations at trial and

cannot be resurrected on brief. See CSI Hydrostatic Testers,

Inc. v. Commissioner, 103 T.C. 398, 399 n.1 (1994), affd. 62 F.3d

136 (5th Cir. 1995); Church of Scientology v. Commissioner, 83

T.C. 381 (1984), affd. 823 F.2d 1310 (9th Cir. 1987).

As reflected in our findings of fact, we hold that the

expenditures paid from the Administration Co. and Principal

Services special E accounts were Kanter's funds, and therefore

the Kanters are entitled to the disallowed Schedule A and C

deductions and expenses claimed for the years 1986 through 1989.

Issue 10. Whether Kanter, in 1983, Realized Capital Gains Under
Section 357(b) and (c) From the Assumption by Cashmere Investment
Associates, Inc., of Partnership Interests Having Negative
Capital Accounts and Whether, Under Section 453, the Installment
Method was Available for the Reporting of Such Gains

FINDINGS OF FACT

In the notice of deficiency for 1983, respondent made the

following determinations:

Income From Assumption by Cashmere Investment
Associates, Inc. of Liabilities in Excess of Basis

It is determined that you received directly or
indirectly additional capital gain income of $476,889
on the transfer of property to a corporation in 1983.
It is determined that your grantor trusts had a zero
basis and a negative capital account of $476,889 in the
partnership interests transferred. The transfer of
other assets to the corporation by the trusts has no
 - 392 -

bona fide business purpose, was made only to avoid
income tax, and, thus, is ignored for Federal income
tax purposes. Your net capital gain income is,
therefore, increased by $190,756.

capital gain income $476,889
capital gain deduction (286,133)
net long-term capital gain $190,756

Income From Sale of Cashmere Investment Associates, Inc.
Stock.

It is determined that you received additional
capital gain income in the amount of $947,000 from the
sale of stock by grantor trusts whose income is
reportable on your Federal income tax return in 1983.
The installment sale by the trusts was a sale of
property to a related party (the first disposition.)
The related-party purchaser disposed of the property
(the second disposition) before the grantor trusts
received any payments under the first disposition. It
is determined, therefore, that the total contract price
for the first disposition is treated as received by the
grantor trusts at the time of the second disposition.
It is further determined that the basis of the grantor
trusts in the stock sold was zero. Accordingly, your
taxable income for 1983 is increased by $378,800 - the
amount of the net long-term capital gain.

capital gain $947,000
capital gain deduction (568,200)
net long-term capital gain $378,800

Assumption of liabilities $190,756
Sale of stock 378,800
$569,556

Total increase in long-term
capital gain $569,556

During the 1970's, Kanter was involved in a number of real

estate developments with a developer named Sam Zell (Zell). One

of Zell's business associates was Robert Lurie (Lurie).
 - 393 -

The properties in question were owned by various

partnerships (collectively known as the Equity Financial Group),

and Kanter's interests were held through the BWK Revocable Trust,

the Everglades Trusts 1-5, the BWK Family Trusts, and Holding Co.

Other interests in the real estate partnerships were held by

members of Kanter's former law firm or their family trusts.

The designated beneficiaries of the BWK Revocable Trust, the

BWK Family Trusts, and the Everglades Trusts 1-5 were members of

Kanter's family. Kanter was the trustee of the BWK Revocable

Trusts, and Roger Baskes was the trustee of Everglades Trusts 1-

5. The BWK Revocable Trust and the Everglades Trusts 1-5 were

grantor trusts for Federal tax purposes whose income was

generally reportable on Kanter's individual Federal income tax

returns, since Kanter was the "deemed owner" of the trusts.

The shareholders of Holding Co. were Kanter family trusts

(i.e., trusts with respect to which the designated beneficiaries

were members of Kanter's family). Weisgal was the president of

Holding Co.

Kanter's 28 real estate partnership interests, the entity

which held each interest, and the percentage of each such

interest at the beginning of 1983 are set forth below:

Entity Partnership Interest Percentage

BWK Revocable Trust Diversified River Bend 18.60
Partnership
BWK Revocable Trust Bajomonte Associates 27.33
 - 394 -

Entity Partnership Interest Percentage

Everglades Trusts 1-5 Wayside Partners 5.01
Everglades Trusts 1-5 Manderville Partners 3.86
Everglades Trusts 1-5 Shady Crest Investors 8.43
Everglades Trusts 1-5 Palo Alto Partners 8.90
Everglades Trusts 1-5 Diversified Raintree 8.269
Partners
Everglades Trusts 1-5 Cedar Cove Partners 8.71
Everglades Trusts 1-5 Diversified Boot Lake 8.706
Partners
Everglades Trusts 1-5 Edgewater Partners 3.53
Everglades Trusts 1-5 Kentucky Holdings 9.296
Everglades Trusts 1-5 Walnut Creek Group 4.03

Everglades Trusts 1-5 Candlelite Apartments 8.8255
Everglades Trusts 1-5 Village Square - Lexington 12.51
Everglades Trusts 1-5 Worthman Office Mall 23.75
Everglades Trusts 1-5 Kon Tiki Apartments 16.667
Everglades Trusts 1-5 J.S. Investors 7.50
Everglades Trusts 1-5 Cove Realty Co. 8.00
Everglades Trusts 1-5 Diversified Hillsborough 8.27
Partners
Everglades Trusts 1-5 Midwest Properties Group 8.44
Everglades Trusts 1-5 Washtenew Management Co. 8.17
Everglades Trust 1-5 Tradewinds Shopping Center 5.88

BWK Family Trusts Centennial Investors 17.02

Holding Co. River Bend Investors 3.40
Holding Co. C & W Investors 30.00
Holding Co. First Commitment & Dev. 42.50
Holding Co. 332 Equity Partnership 18.75
Holding Co. Katy Land Co. 16.67

The River Bend Investors partnership interest owned by

Holding Co. was previously held by the Bea Ritch Trusts and was

transferred to Holding Co. on or about January 1, 1983.

Some time during the spring of 1982, Zell approached Kanter

about Zell’s purchasing all the other partners' interests in the

real estate. Kanter was willing to sell his interests but was

concerned about the tax consequences. Kanter's major concern was
 - 395 -

that most of the partnership interests held by his grantor trusts

had negative capital accounts, and an outright sale would have

realized significant gains (assumption of liabilities in excess

of the partners' bases). Specifically, the aggregate negative

capital accounts for the interests held by the grantor trusts as

of May 15, 1983, was $476,888.60, as follows:

Entity Partnership Interest Cap. Acct.

BWK Rev Trust Bajomonte Associates ($180,270.00)
BWK Rev Trust Diversified River Bend
Partners (37,622.05)
BWK Rev Trust Diversified Stephenson's
Lake Partners (30,364.70)
Everglades Trusts Wayside Partners (4,806.00)
Everglades Trusts Shady Crest Investors (36,425.79)
Everglades Trusts Diversified Raintree
Partners (15,942.00)
Everglades Trusts Edgewater Partners (24,798.38)
Everglades Trusts Kentucky Holdings (4,703.19)
Everglades Trusts Walnut Creek Group (2,095.05)
Everglades Trusts Candlelite Apartments (77,401.56)
Everglades Trusts Village Square Lexington (15,032.32)
Everglades Trusts Wortham Office Mall (12,751.50)
Everglades Trusts Kon-Tiki Apartments (25,606.66)
Everglades Trusts Diversified Hillsborough
Partners 3,979.00
Everglades Trusts Manderville Partners 10,353.65
Everglades Trusts Palo Alto Partners 1,219.11
Everglades Trusts J.S. Investors 9,305.00
Everglades Trusts Cove Realty 14,098.00
Everglades Trusts Midwest Realty 13,834.56
Everglades Trusts Washtenew Management 2,766.09
Everglades Trusts Tradewinds Shopping Center 3,107.00

Net capital accounts (476,888.60)

The price (fair market value) allocated to each entity was

as follows:
 - 396 -

Entity Partnership Interest Price (FMV)
BWK Rev Trust Bajomonte Associates --
BWK Rev Trust Diversified River Bend --
Partners
BWK Rev Trust Diversified Stephenson's --
Lake Partners
Total FMV-BWK Revocable Trust $12,321.64

Entity Partnership Interest Price (FMV)

Everglades Trusts Wayside Partners --
Everglades Trusts Shady Crest Investors --
Everglades Trusts Diversified Raintree --
Partners
Everglades Trusts Cedar Cove Partners --
Everglades Trusts Diversified Boot Lake --
Partners
Everglades Trusts Edgewater Partners --
Everglades Trusts Kentucky Holdings --
Everglades Trusts Walnut Creek Group --
Everglades Trusts Candlelite Apartments --
Everglades Trusts Village Square Lexington --
Everglades Trusts Wortham Office Mall --
Everglades Trusts Kon-Tiki Apartments --
Everglades Trusts Diversified Hillsborough --
Partners
Everglades Trusts Manderville Partners --
Everglades Trusts Palo Alto Partners --
Everglades Trusts J.S. Investors --
Everglades Trusts Cove Realty --
Everglades Trusts Midwest Realty --
Everglades Trusts Washtenew Management --
Everglades Trusts Tradewinds Shopping Center --
Total FMV-Everglades Trusts 657,000

BWK Family Trusts Centennial Investors 30,000

Holding Co. River Bend Investors --
Holding Co. C & W Investors --
Holding Co. First Commitment & Dev. --
Holding Co. 332 Equity Partnership --
Holding Co. Katy Land Co. –
Total FMV-Holding Co. 520,000
 - 397 -

1. The I.R.C. Section 351 Exchange and Related Transactions

In order to avoid the realization (or recapture) of gains

resulting from the sale of the real estate partnership interests,

Kanter utilized Cashmere Investment Associates, Inc. (Cashmere),

a shell corporation and, on or about May 15, 1983, directed the

trusts to transfer their partnership interests into Cashmere in a

section 351 nontaxable exchange for stock.

Cashmere was incorporated on February 2, 1982, in Delaware

but had never been activated until the aforesaid transaction.

Cashmere's board of directors consisted of Meyers and Weisgal.

Cashmere's president was Weisgal, its secretary was Sharon

Bayers, and its treasurer was Meyers.

The number of shares and classes of Cashmere's stock

received by the trusts in exchange for their partnership

interests were as follows:

Shares of Stock
Shareholder Common Stock Class A Preferred

BWK Revocable Trust 50 241.274
Everglades Trusts 1-5 400 257.226
BWK Family Trusts 30 --
Holding Co. 520 --

In order to offset the negative capital accounts of the

partnership interests and to avoid the realization of taxable

gains that would result from Cashmere assuming liabilities (the

negative capital accounts), Kanter caused the trusts to transfer

to Cashmere on May 15, 1983, eight notes receivable (assets) held
 - 398 -

by the trusts or recently transferred to them by or at the

direction of Kanter.

The specific notes receivable transferred to Cashmere along

with the partnership interests were as follows:

Maker Payee Amount

Holding Co. Everglades Trusts 1-5 $90,000
Burton W. Kanter Everglades Trusts 1-5 34,230
Beach Trust Burton W. Kanter 128,725
HELO Everglades Trusts 1-5 94,800
GO's Associates Everglades Trusts 1-5 38,000
ARO Trusts Burton W. Kanter 25,045
Baroque Trusts Burton W. Kanter 66,000
BWK Children's Trust Burton W. Kanter 21,700
Total 498,500

Each note was dated May 1, 1983, and was, by its terms, due

and payable on August 31, 1983. Each of the notes from the Beach

Trust ($128,725), Baroque Trusts ($66,000), BWK Children's Trusts

($21,700), and ARO Trusts ($25,045) stated that they were

transferred, sold, and assigned to the BWK Revocable Trust as of

May 1, 1983. However, the Beach Trust note was not actually

"transferred sold and assigned to the BWK Revocable Trust" prior

to August 31, 1983.

The trustee of the Beach Trust was Albert Morrison

(Morrison), the grantor was Kanter, and the beneficiaries were

members of Kanter's family. The trustee of the Baroque Trusts

was Grogan, the grantor was Kanter, and the beneficiaries were

members of Kanter's family. For Federal tax purposes, Kanter was

the "deemed owner" of the Baroque Trusts, and income of these
 - 399 -

trusts was generally reportable on Kanter's individual Federal

income tax returns.

Kanter did not present any evidence to establish the

genuineness of the alleged indebtedness represented by the notes.

No true debtor-creditor relationship existed; there was no

intention to repay, and there was no business purpose for any of

the notes.

2. Sale of Cashmere Stock to Waco

On July 12, 1983, the BWK Revocable Trust and the Everglades

Trusts 1-5 sold all of their respective stock (common and

preferred shares) in Cashmere to Waco Capital Corp. (Waco). Waco

was a corporation organized under the laws of Delaware, and

Meyers was its president. The sole shareholder of Waco was the

Bea Ritch Trusts. Waco later changed its name to Windy City,

Inc., and continued to be owned (in whole or in part) by the Bea

Ritch Trusts.

The BWK Revocable Trust entered into an agreement with Waco

whereby the trust agreed to sell its 50 shares of common and

241.274 shares of class A preferred stock of Cashmere for a

promissory installment note in the amount of $290,000.

Similarly, the Everglades Trusts 1-5 entered into an agreement

with Waco whereby the trusts agreed to sell their 400 shares of

common and 257.226 shares of class A preferred stock of Cashmere

for a promissory installment note in the amount of $657,000.
 - 400 -

Pursuant to the parties' agreements, the promissory

installment notes had payment terms as follows:

Due Date BWK Revocable Trust Everglades Trusts 1-5

1/15/84 $50,000 --
2/15/84 -- $100,000
1/15/86 50,000 --
7/11/93 190,000 557,000
Total 290,000 657,000

In addition, and on the same day, Holding Co. and the BWK

Family Trusts sold their shares of Cashmere common stock to WACO

for promissory installment notes in the amounts of $520,000 and

$30,000 respectively.

The promissory installment notes given to the trusts by WACO

were secured by the Cashmere stock, subject to Waco's option to

substitute as collateral the guaranties of the sole shareholder

of Waco and pledges of various partnership interests (known in

the aggregate as Cablevision). This option to substitute

collateral was subsequently exercised by Meyers, on behalf of

WACO's sole shareholder, The Bea Ritch Trusts.

Kanter did not present any evidence to establish that WACO

made any payments on the installment promissory notes, including

the balloon installment payments due on July 11, 1993. Kanter's

records reflect an inconsistent reporting of the installment sale

to Waco.

Kanter then negotiated the sale of the Cashmere stock held

by Waco to Equity Financial Management Co. (Equity Financial),
 - 401 -

which was owned and operated by Zell and Lurie. Zell and Lurie,

however, did not want, and would not accept, the notes receivable

held by Cashmere along with the partnership interests.

Therefore, the notes were paid off by checks drafted on

Administration Co. Inc.'s Special E Account, purportedly on

behalf of the Bea Ritch Trusts, on August 31, 1983, prior to the

sale of the Cashmere stock to Equity Financial. After the notes

were paid off, Cashmere had assets consisting of the partnership

interests and $498,500 in cash.

The checks written on August 31, 1983, by Administration Co.

in payment of the notes are as follows:

Ck No. Payee Amount

1315 Holding Co. $90,000
"For BRT"
1316 BWK Revocable Trust 34,230
"For BRT"
1317 Beach Trust 128,725
"For Trust (BRT)"
1318 Cashmere 94,800
"For HELO"
1319 Cashmere 38,000
"For GLS Assoc"
1320 Cashmere 25,045
"For ARO"
1321 Cashmere 66,000
"For Baroque Tr."
1322 Cashmere 21,700
Total 498,500

Each check was signed on behalf of Administration Co. by

Meyers. None of the checks written by Administration Co. in

payment of the notes was reflected on Administrative Co.'s

general ledger for the period ending June 30, 1984.
 - 402 -

Kanter presented no evidence as to whether the funds for

payment of the notes were in fact the funds of the Bea Ritch

Trusts and, if so, why the payments were made by the Bea Ritch

Trusts since the Bea Ritch Trusts were not the makers of the

notes.

With respect to those checks that were not specifically made

out to Cashmere for payment of the notes, the debtors on the

notes (the Beach Trust, the BWK Revocable Trust, and Holding Co.)

were instructed to transmit checks themselves drafted on their

own accounts to Cashmere. Administration Co., in turn, provided

these entities with the funds for payment of the notes, which

funds are represented by three checks.

There is no documentary evidence (promissory notes, payment

schedules, canceled checks representing interest or principal

payments, or other records) in the record to substantiate that

the amounts provided to the Beach Trust, the BWK Revocable Trust,

and Holding Co. by Administration Co. for the payment of the

notes held by Cashmere were "loans" from the Bea Ritch Trusts, or

that such "loans" were paid back. No interest or principal was

ever paid in connection with any of the so-called "loans" made by

the Bea Ritch Trusts in exchange for payment of the notes held by

Cashmere.
 - 403 -

3. Sale of Cashmere Stock by WACO to Equity Financial

Kanter provided a legal opinion, dated September 1, 1983, to

Equity Financial regarding "certain matters in conjunction with

the purchase * * * of Cashmere Investments Associates, Inc."

On September 2, 1983, Waco sold the Cashmere stock to Equity

Financial for $1,647,500, which was paid by check. Cashmere had,

as assets, cash of $498,500, consequently the remainder of the

consideration, $1,149,000 related to the acquisition costs of the

partnership interests. Zell and Lurie were not interested in the

Cashmere stock. Their sole interest was to buy the partnership

interests outright, but this was the only way that Kanter would

permit the sale.

Immediately after the sale, Zell and Lurie liquidated

Cashmere because its limited purpose was fulfilled.

4. How Sale of Cashmere Stock Was Reported on Tax Returns

Kanter did not report any income from, nor in any way

reflect, the installment sale of Cashmere stock on his 1983 and

1986 Federal tax returns.

Kanter reported installment sale income on Forms 6252

attached to his 1984 and 1985 Federal tax returns, as follows:
 - 404 -

1984

Description of property: "via BWK Revocable Trust, 50 shs
common, 241.274 shs Class A Pfd. - Cashmere Investment
Associates, Inc."

Date Acquired: "5/15/83" Date sold: "7/11/83"

Was property sold to a related party after May 14, 1980?
"no"

Gross profit ratio: "104.25"

Payments received during year: "50,000"

Taxable part of installment sale: "52,125"

1984

Description of property: "via Everglades Trusts, 400 shs
common, 257.266 shs Class A Pfd. - Cashmere Investment
Associates, Inc."

Date Acquired: "5/15/83" Date sold: "7/12/83"

Was property sold to a related party after May 14, 1980?
"no"

Gross profit ratio: "95.6776"

Payments received during year: "100,000"

Taxable part of installment sale: "95,680"

1985

Description of property: "via BWK Revocable Trust, 50 shs
common, 241.274 shs Class A Pfd. - Cashmere Investment
Associates, Inc."

Date Acquired: "5/15/83" Date sold: "7/11/83"

Was property sold to a related party after May 14, 1980?
"no"

Gross profit ratio: "104.25"

Payments received during year: "50,000"
 - 405 -

Taxable part of installment sale: "52,125"

Kanter's use of Cashmere and his manipulation and transfer

of promissory notes to Cashmere for the purpose of offsetting the

negative capital accounts of the trusts' partnership interests

served no bona fide business purpose. His attempt to structure a

nontaxable section 351 transaction was done only to avoid the

realization of taxable capital gains.

Similarly, the utilization of WACO as an intermediary in the

sale of the trusts' real estate partnership interests to Equity

Financial served no bona fide business purpose. It was done only

to avoid taxation.

Waco was a related party to both the BWK Revocable Trust and

Everglades Trusts 1-5.

OPINION

Although the parties disagree as to whether or not the

transfer of the promissory notes and the partnership interests by

Kanter’s grantor trusts to Cashmere constituted a valid transfer

under section 351, we find it unnecessary to decide the issue on

that basis. However, we reject Kanter’s contention that the

issue was not challenged by respondent under section 357(b). The

language in the notice of deficiency quoted above clearly shows

that respondent challenged the series of transactions under

section 357(b) even though section 357(b) is not cited.
 - 406 -

It is our view that Kanter’s transfer of his grantor trusts’

real estate partnership interests to Cashmere and the series of

transactions which followed thereafter constituted a tax

avoidance purpose under section 357(b).

The parties agree that the trusts were grantor trusts with

respect to which Kanter was the "deemed owner". The grantor

trust rules generally provide that any taxpayer treated as the

deemed owner of any portion of a trust will include in the

computation of his own taxable income those items of income,

deductions and credits against tax of the trust which are

attributable to the taxpayer's portion of the trust. See secs.

671-679.

Section 1001 provides the general rules regarding the

computation and recognition of gain or loss from the sale or

other disposition of property. Section 1001(c) provides that

"except as otherwise provided in this subtitle, the entire amount

of the gain or loss on the sale or exchange of property * * *

shall be recognized."

Section 351 sets forth a significant exception to the

recognition provisions. It provides that no gain or loss is

recognized when a taxpayer transfers property to a controlled

corporation solely in exchange for the corporation's stock. See

Sec. 351(a). Property, for the purposes of section 351, includes

partnership interests. The purpose for the nonrecognition
 - 407 -

exception for transfers to controlled corporations is to

encourage the capitalization of businesses by granting beneficial

tax treatment to the transfer of appreciated property to

corporations controlled by the transferor.

Section 357(a) provides generally that if the taxpayer

receives property which would be permitted under section 351

without the recognition of gain, and another party, as part of

the consideration, assumes a liability of the taxpayer or

acquires from the taxpayer property subject to a liability, then

such assumption shall not be treated as money or other property

and the exchange of property is valid under section 351.

However, section 357(b)(1) provides generally that if,

considering the nature of the liability and the circumstances in

which the arrangement for assumption or acquisition of the

liability was made, it appears that the principal purpose of the

taxpayer with respect to the assumption was to avoid Federal

income tax on the exchange or was not for a bona fide business

purpose, then such assumption shall, for purposes of section 351,

be considered as money received by the taxpayer on the exchange.

The clear objective desired by the real parties in interest

(Kanter, Zell, and Lurie) was to sell the real estate partnership

interests held by the trusts for cash. Hence, viewing the

transactions as a whole, and in the context of the parties'

motivations, it is clear that there was no business purpose for
 - 408 -

the convoluted series of exchanges in which these entities

participated and in particular, the purported transfer of notes

receivables to the grantor trusts prior to the section 351

exchange with Cashmere. The primary reason for activating

Cashmere and utilizing its stock was to avoid the taxation of

capital gains realized by a purchaser's assumption of partnership

interests which had negative capital accounts (representing money

owed to the partnerships by the partners). Additional tax

motivations are also apparent, namely, in Kanter's attempted

deferral of the recognition of gain by applying the installment

sale provisions, while at the same time receiving immediate cash

payment for the interests (in excess of $1 million paid to his

controlled entity, Waco).

The entire plan for selling the partnership interests to

Zell and Lurie took place between May 15 and September 2, 1983.

In that "3½-month period," the Cashmere stock was transferred

three times (to Kanter's grantor trusts, to Waco, and to Equity

Financial). With the exception of Equity Financial, each of the

entities involved was controlled by Kanter. Cashmere engaged in

no other activities before, during, or after that limited period

of time.

Equity Financial purchased the stock of Cashmere from Waco.

Cashmere’s assets consisted of $498,000 cash which Cashmere

acquired from the purported payments of the notes by
 - 409 -

Administration Co. and the Bea Ritch Trusts. The only other

assets of Cashmere were the partnership interests--which were the

only assets Zell and Lurie wanted.

With respect to the notes transferred by the trusts to

Cashmere, Kanter was acting in some instances as both the debtor

and the creditor (i.e., notes from the Beach Trust, the BWK

Family Trust and the Baroque Trusts, with respect to which

entities Kanter was the grantor and deemed owner as well as the

original payee on the note and on one note in which Kanter was

the maker). There was an absence of regular business records

maintained or presented in connection with all of the alleged

notes, and at least one of the notes (GO's Associates) related to

indebtedness incurred in connection with a bogus computer leasing

transaction.

The makers of each of these notes were Kanter individually

or his controlled entities. Four of the notes were transferred,

sold, and assigned to the BWK Revocable Trust as of May 1, 1983,

although it is clear that, in at least one case, the assignment

did not take place before August 31, 1983. The total principal

amount of the notes transferred to Cashmere almost exactly offset

the aggregate negative capital accounts of the partnership

interests. The notes were all payable on August 31, 1983, and

were purportedly paid by checks drafted on Administration Co.'s

special E account.
 - 410 -

The checks written by Administration Co. (purportedly on

behalf of the Bea Ritch Trusts) in payment of the notes were not

reflected on Administrative Co’s. general ledger for the period

ending June 30, 1984. No evidence was presented to establish

that the Bea Ritch Trusts used their own funds to pay off the

notes.

In short, no evidence of any business purposes for any of

the notes was presented by Kanter or that the notes represented

valid debts. Rather, the notes and cash transferred constituted

a circular flow between and among Kanter-controlled entities with

the purpose being to avoid immediate taxable gains. Given the

complex series of transactions employed to achieve a simple sale

of partnership real estate interests for cash, we think that the

integral aspect of the plan was to avoid Federal income tax on

the exchange and the inclusion of promissory notes purportedly

held by the trusts and made part of the section 351 exchange

lacked a bona fide business purpose.

The policy behind section 351 is to encourage the formation

and/or capitalization of corporations by providing tax relief in

those instances where individuals would be hesitant to transfer

appreciated property because of the taxable gains that otherwise

would be realized and recognized. The tax-free exchange rules

are not intended to provide a loophole; i.e., the transfer of
 - 411 -

fictitious assets for avoiding the taxation of such gains. Such

policy is borne out by the provisions of section 357(b).

We conclude that Cashmere's assumption of the partnership

interests subject to liabilities (the aggregate of the negative

capital accounts) was principally for a tax avoidance purpose.

Consequently, gain equal to the liabilities is recognized by the

trusts, and thus by Kanter as their grantor, under section

357(b). The burden was on Kanter to prove by a clear

preponderance of the evidence that tax avoidance was not his

principal purpose or that he had a valid business purpose. See

sec. 357(b)(2). He has not done so. As we have previously

indicated, we believe the entire series of transactions was

structured by Kanter to avoid taxation on otherwise recognizable

gains. We find that his principal purpose in having Cashmere

acquire the partnership interests subject to the liabilities was

to avoid tax; it served no business purpose, and it thus

generated gain to him equal to the amount of the liabilities to

which the partnership interests were subject at the time of the

exchange; i.e., the amounts of their negative capital accounts.

See sec. 357(b)(1).

Alternatively, section 357(c) provides that, in the case of

a section 351 exchange to which section 357(b) does not apply, if

the total liabilities assumed together with the total liabilities

to which the property transferred is subject to exceed the
 - 412 -

adjusted basis of all the property transferred, the excess is

treated as gain from the sale or exchange of the property

transferred. Kanter admittedly was attempting to avoid section

357(c) by transferring eight artificial notes receivable in a

total amount to offset exactly the aggregate negative capital

accounts of the partnership interests. These artificial

receivables do not constitute bona fide assets in which the

trusts had any basis. Accordingly, the amount of the liabilities

assumed ($476,889) is treated as gain on the sale or exchange of

the property transferred and therefore is taxable to Kanter as

the deemed owner of the trusts.

The second part of respondent's adjustment ($378,800)

relates to Kanter's use of the installment sale method to report

gain from his grantor trusts' sale of stock.

The Cashmere stock was sold to Waco in an installment sale

on July 12, 1983. The terms of the sale provided for the

payments to be made to the trusts from January 15, 1984, through

July 11, 1993. Waco subsequently resold the stock to Equity

Financial on September 2, 1983, clearly within 2 years of its

purchase from the trusts and almost 10 years prior to the date

the final balloon payments were scheduled to be made in

connection with the initial installment sale.

Section 453(e)(1) provides that if a person sells property

to a related party (the first disposition) under the installment
 - 413 -

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. Thus, the installment method of reporting the sale of

Cashmere stock to Waco was not available because Waco was a

related party under the attribution rules of sections 318(a) and

267(b). Waco’s stock was owned by BRT, the beneficiaries of

which were members of Kanter’s family who were also beneficiaries

of the trusts selling the stock. The subsequent disposition of

the stock by Waco took place within 2 years of the original sale

when all payments under the installment sale had not been made to

the grantor trusts. Therefore, the entire price of $947,000 for

which the grantor trusts sold their Cashmere stock to Waco was

deemed realized in 1983, the year of the sale.

It is noted that Kanter did not correctly report the

installment sale on his Federal income tax returns. Although he

was not to receive any payments until 1984, he did not disclose

the existence of the sale, as required, on his 1983 tax return,

that being the tax year in which the sale occurred. Furthermore,

when he did report the sale on Form 6252 attached to his 1984 tax

return, he answered "no" to the question on line D ("Was property
 - 414 -

sold to a related party after May 14, 1980?). And there is no

evidence as to whether the balloon payments due on July 11, 1993

(representing $747,000 of the total $947,000 sales price), were

ever made, received or reported.

Accordingly, we sustain respondent's determination that

Kanter had an additional net long-term capital gain of $378,800

in 1983 resulting from the installment sale of stock by the

grantor trusts.

Issue 11. Whether Kanter Is Entitled to Research and Development
and Business Expense Deductions From Immunological Research
Corporation for 1979

FINDINGS OF FACT

On their Federal income tax returns for 1979 through 1982,

the Kanters claimed $311,478, $10,962, $711, and $1,590 as

Kanter's distributive share of losses from Immunological Research

Corp. (IRC), an S corporation, allocable to three grantor trusts,

for which Kanter was the deemed owner; namely, Tablet Trust,

Capsule Trust, and Liquid Trust.

Although respondent issued notices of deficiency to Kanter

for the years 1979 through 1982, respondent did not disallow the

losses claimed by Kanter from IRC in the notices of deficiency.

However, in an Amendment to Answer in docket No. 3456-88,

respondent affirmatively alleged that Kanter's claimed loss in

the amount of $311,478 for 1979 was not allowable. Respondent

also asserted that any underpayment from the claimed loss from
 - 415 -

IRC was a substantial underpayment due to tax-motivated

transactions under section 6621(c). Leave to file respondent's

Amendment to Answer was granted by the Court.

The facts relating to this issue were considered and found

by this Court in Estate of Cook v. Commissioner, T.C. Memo. 1993-

581, which involved another shareholder in IRC. In that case, we

sustained respondent's disallowance of such expenses as research

and experimentation expenses under section 174(a), as well as

respondent’s disallowance of similar expenses claimed by two

other S corporations that were engaged in the same activity,

Antiviral Research Corp. (ARC) and Biological Research Corp.

(BRC). Kanter was not a stockholder in the other two

corporations. The parties herein stipulated to the record of

Estate of Cook v. Commissioner, supra, except as to those

portions of the record relating only to the other two S

corporations.

During 1979, Kanter and three other individuals (including

George B. Cook, whose estate was the taxpayer in Estate of Cook

v. Commissioner, supra), invested in IRC, an S corporation that

they had organized. 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 ostensibly to engage in. Shortly after IRC was organized,

IRC entered into a Research, Development, and License Agreement
 - 416 -

(the research or licensing agreement) with Newport Pharmaceutical

International, Inc. (Newport). Newport was then engaged in the

manufacture, marketing, research, and development of

pharmaceutical compounds. One of the compounds owned by Newport

was identified as the NPT-15000 series, in which Newport owned an

undivided one-half interest that it had acquired from the

discoverer of the compound, the Sloan-Kettering Memorial

Institute for Cancer Research (Sloan-Kettering), in 1978. At

that time, this particular compound was still in the experimental

stage of development. In the 1978 transaction, the transfer of

the one-half interest in the subject compound to Newport included

the transfer of 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 sale agreement. In the 1978 sale

agreement, Newport was given the exclusive right to exploit the

patent rights to the subject compound on a worldwide 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.
 - 417 -

The ostensible purpose in organizing IRC was for IRC to

enter into 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 and 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 reservation

of patent rights, and, accordingly, the licensing agreement

between IRC and Newport was structured with the intent that

exploitation of the subject compound by IRC or its licensees

would not violate Sloan-Kettering's rights. With that in mind,

the research agreement between IRC and Newport contained the

following provisions:

2. Ownership of Project Results.
Any and all products, processes, compounds,
inventions, ideas, patents, patent rights, technical
information, data and other proprietary know-how
resulting or deriving from the Project, including all
improvements thereto, and any other rights to
commercially exploit the Project and the products and
results thereof, including but not limited to,
licensing and distribution rights, shall be the sole
and exclusive property of the corporation [i.e., IRC];
provided, however, the Corporation shall have no
ownership rights or rights which may be deemed to be
a sub-license to the extent that any of the foregoing
constitutes a "Patent Right" or an invention or
improvement covered thereby as defined in the agreement
 - 418 -

dated March 28, 1978 between Newport and Sloan-
Kettering Institute * * *. [Emphasis added.]

Pursuant to this licensing agreement, IRC paid Newport,

during 1979, $980,000 for Newport's services for the research,

experimentation, and further development of the compound NPT-

15392. On his 1979 Federal income tax returns, Kanter claimed a

deduction for his portion of the $980,000 research and

experimentation expense. In amended pleadings, respondent

affirmatively alleged that the $311,478 loss claimed by Kanter

from this activity should be disallowed.

OPINION

In Estate of Cook v. Commissioner, T.C. Memo. 1993-581, this

Court sustained respondent's disallowance for the portion of the

$980,000 expense that George Cook had claimed as a section 174(a)

deduction. The parties agreed in Estate of Cook that IRC was not

engaged in a trade or business within the meaning of section

162(a). Kanter here does not contend otherwise. However, he

argues that the expense nevertheless qualified as a deduction

under section 174(a) as a research or experimentation expense.

This Court held in Estate of Cook that 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 be legally entitled to enter into a trade or business

exploiting research and (2) the taxpayer must demonstrate a
 - 419 -

realistic prospect that it would do so. It was decided that IRC

failed to meet both of these tests. Significant 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). 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.

This Court held in Estate of Cook that the reservation in

the agreement between IRC and Newport, taken together with the

broad definition of "Patent Rights" in the agreement between

Newport and Sloan-Kettering, left very little, if anything, to be

acquired by IRC in the 1979 licensing agreement between Newport

and IRC. The Court stated: "In light of this definition, it is

hard to visualize that [IRC] obtained ownership of anything that

could be commercially exploited in a trade or business." The

Court surmised that virtually anything Newport developed would

constitute a "Patent Right", and, if so, the ownership of such

improvement or technology would not belong to IRC.
 - 420 -

There were other facts of the case that the Court discussed

to support the conclusion that IRC was not engaged in a trade or

business and did not have the capacity to engage in a trade or

business. The other findings were not seriously challenged by

Kanter in the instant cases, and the Court does not consider it

necessary to discuss those facts here.

Kanter was the only witness to testify in the present case

with respect to this issue. No documentary evidence was

presented to corroborate his testimony, which was directed toward

establishing that there were certain rights to 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.

Section 174(a)(1) generally provides:

A taxpayer may treat research or experimental
expenditures which are paid or incurred by him during
the taxable period in connection with his trade or
business as expenses which are not chargeable to
capital account. The expenditures so treated shall be
allowed as a deduction.

Section 174(a)(1) applies to expenditures paid or incurred by a

taxpayer for research or experimentation undertaken directly by a

taxpayer or to expenditures paid or incurred by a taxpayer for

research or experimentation carried on by another person or

entity on the taxpayer's behalf. See sec. 1.174-2(a)(8), Income

Tax Regs.
 - 421 -

To be entitled to deductions for research and experimental

expenditures, a taxpayer is not required currently to 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. See Snow v. Commissioner, 416 U.S. 500, 503-504

(1974). Nevertheless, in Green v. Commissioner, 83 T.C. 667,

686-687 (1984), this Court stated:

For section 174 to apply, the taxpayer must still be
engaged in a trade or business at some time, and * * *
[the Court] must still determine, through an
examination of the facts of each case, whether the
taxpayer's activities in connection with a product are
sufficiently substantial and regular to constitute a
trade or business for purposes of such section. [Fn.
ref. and citations omitted.]

A taxpayer must be more than a mere investor to be entitled

to deductions for research and experimental expenditures under

section 174. See id. at 688-689, see also Levin v. Commissioner,

87 T.C. 698, 725-726 (1986), affd. 832 F.2d 403 (7th Cir. 1987).

In the case of an entity that claims deductions under

section 174, the relevant inquiry is whether the entity has any

realistic prospect of entering into a trade or business involving

the technology under development. See Spellman v. Commissioner,

845 F.2d 148, 151 (7th Cir. 1988), affg. T.C. Memo. 1986-403;

Diamond v. Commissioner, 92 T.C. 423, 439 (1989), affd. 930 F.2d

372 (4th Cir. 1991).

As these cases demonstrate, when an entity contracts out the

performance of the research and development in which it intends
 - 422 -

to engage, all of the surrounding facts and circumstances are

relevant to the inquiry into whether such entity has any

realistic prospect of entering into a trade or business with

respect to the technology under development. The inquiry

includes consideration of the intentions of the parties to the

contract for the performance of the research and development, the

amount of capitalization retained by the entity during the

research and development contract period, the exercise of control

by the entity over the person or organization doing the research,

the existence of an option to acquire the technology developed by

the organization conducting the research and the likelihood of

its exercise, the business activities of the entity during the

period in question, and 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 dealt with, among other things,

the entitlement of another IRC shareholder (namely, George Cook)

to a deduction for IRC's claimed 1979 research and development

expense. The Court rejected the taxpayers' contention that a

realistic prospect existed of IRC's entering into a trade or
 - 423 -

business to exploit the results of the research and

experimentation undertaken by Newport.

Respondent has the burden of proof on this issue.

Respondent points out that the identical 1979 IRC research and

development and business expense issues were previously presented

to and decided by this Court in Estate of Cook and contends that

the Court's reasoning and conclusions in that case are equally

applicable here.

Kanter, on the other hand, contends that the issues are

purely factual, and that the following distinctions from Estate

of Cook are present in the instant cases: (1) Respondent, not

Kanter, bears the burden of proof; (2) Kanter's testimony was

entered in evidence here, unlike in Estate of Cook; and (3) the

Court's conclusions here with respect to IRC should not be based

upon certain "irrelevant" facts concerning ARC and BRC, as Kanter

implies happened in Estate of Cook. Kanter maintains that almost

all of the facts concerning ARC and BRC that were discussed in

the Estate of Cook opinion are irrelevant here because (1) he was

not a shareholder of either ARC or BRC, and (2) all events

relating to ARC and BRC occurred after 1979. In particular, he

asserts 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 light of the
 - 424 -

specific exclusion in the parties' written stipulation of those

portions of the Estate of Cook record regarding only ARC and BRC.

Preliminarily, we note that the parties, for purposes of the

instant cases, generally stipulated in evidence the Estate of

Cook record, except for such evidence that related only to ARC

and BRC. Thus, as we interpret the parties' stipulation, the

evidence presented in Estate of Cook that would be relevant to

ARC, BRC and IRC alike (not including perhaps the testimony of

Dr. Charles Altschuler, on which the Court does not rely) would

be considered as evidence in the instant cases and could be

considered in resolving the IRC issues for 1979. We do not

construe the parties' stipulation to limit the evidence here to

only those portions of the Estate of Cook case's evidentiary

record that Kanter considers "relevant" to IRC and himself.

On this record, we conclude that respondent has established

that Kanter was not entitled to deduct the claimed 1979 IRC

research and development expenses under section 174(a). The

evidence shows 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 R&D and License Agreement because there was essentially

nothing that IRC could acquire. Virtually anything that Newport

developed would almost certainly be a patentable property right

that ipso facto could not be owned by IRC. In Estate of Cook
 - 425 -

this Court previously noted: (1) In view of the broad definition

of the term "Patent Rights", as defined in the March 28, 1978,

agreement between Newport and Sloan-Kettering, it is difficult to

see that IRC acquired 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 exploit the research Newport

conducted in a trade or business because (a) if the research were

sufficiently successful to require the payment of royalties, then

Newport likely would exercise its call option 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 such investment was structured as a research

and development activity in the hope of allowing the investors a

deduction for their investment.

Although Kanter testified in the instant cases, we find his

testimony unconvincing and view it as more in the nature of

advocacy than the presentation of substantive evidence. It does
 - 426 -

not show that our conclusions in Estate of Cook were in error,

nor does it warrant a different result. Essentially, Kanter

misunderstands this Court's reasoning in Estate of Cook. He

argues that we incorrectly assumed that IRC held no ownership

rights in any research developed under the research project.

Kanter contends that IRC did hold "other valuable rights" outside

of any existing and derivative future "Patent Rights" in the NPT-

1500 series of compounds retained by Newport and Sloan-Kettering.

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:

[Kanter]: * * * But it was my understanding and
my belief that there is a body of rights that, unless
encompassed by a specific patent that would be issued *
* * to Sloan-Kettering and Newport, under which they
could theoretically preclude the exploitation of that
limited right, all other rights that might result from
this particular research project did belong to IRC and
that they were broad enough in--as we understood it to
allow for exploitation of a profitable product or to
move to the next stage of possible licensing, if in
fact there was something developed.

The Court: So this body of rights that you are
referring to--would these be rights that would be
considered research and development.

[Kanter]: Well, actually my recollection is--and
the [Cook] record will disclose it more accurately--Dr.
Glasky tried to point out to the Court at that time
that there is in this pharmaceutical field not the
necessity at any given time for a research and
development project that you develop a marketable
product that can go on the shelf in a drugstore, but
that in this field it is common to bring research to a
point where you can license what you have developed to
a large pharmaceutical manufacturer, who will take it
 - 427 -

to another stage to bring it to a commercial product
that will be put on the shelf.

And I can't tell you now what might have
conceivably been developed were this product research
and development to have been successful or gone far
enough, but it was our impression and understanding at
this time that it either would--or could produce
something significant and allow for future research and
licensing or something significant enough to be an
actual product that could be commercial manufactured.
[Emphasis added.]

The Court: But there have been no developments of
these other rights that you are talking about?

[Kanter]: Well, those rights existed. There was
no preclusion of the rights as far as I know, that
nobody took them away in the form of defined patent
rights.

It remains unclear to the Court just what those "rights"

might be. The Court is skeptical that, in the everyday world, an

investor would pay $980,000 for a bundle of ambiguous property

rights, as to which there is no persuasive indication that such

rights could be exploited or developed.

Moreover, this Court's holding in Estate of Cook was not

premised upon IRC's holding no ownership rights whatsoever in the

research, as Kanter implies. Rather in Estate of Cook, this

Court concluded, after considering the totality of the facts and

circumstances, including certain highly relevant factors, that

there was no realistic prospect of IRC's entering into a trade or

business to exploit the technology being developed under the IRC-

Newport R&D and License Agreement.
 - 428 -

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 risk a

license from IRC on technology that Newport and Sloan-Kettering

might have rights to.

Accordingly, we hold that Kanter is 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); Estate of

Cook v. Commissioner, T.C. Memo. 1993-581.

We further hold that Kanter is not entitled to deductions

under section 162 for 1979 with respect to IRC's claimed business

deductions. IRC was not engaged in an active trade or business

during 1979 because its activities fail to satisfy even the "in

connection with" a trade or business standard of section 174.

See Estate of Cook v. Commissioner, supra.
 - 429 -

Issue 12. Whether Kanter had Unreported Partnership Income for
1978

OPINION

In the notice of deficiency for 1978, respondent determined

that the Kanters failed to report partnership income (loss) in

the net amount of $4,953 from the following sources:

T.C. Family Trust ($512)
Everglades Trust No. 1 1,093
Everglades Trust No. 2 1,093
Everglades Trust No. 3 1,093
Everglades Trust No. 4 1,093
Everglades Trust No. 5 1,093
Total 4,953

Kanter did not introduce any evidence on this issue.

Therefore, respondent's determination is sustained.

Issue 13. Whether the Kanters Are Entitled to a Loss From GLS
Associates for 1981

OPINION

On their Federal income tax return for 1981, the Kanters

claimed a loss of $4,283 on Schedule E relating to an entity

referred to as GLS Associates. Respondent disallowed the claimed

loss because the Kanters did not prove that GLS Associates was

engaged in an activity entered into for profit and that

deductible expenses were incurred by it in excess of income. The

Kanters introduced no evidence on the issue. Therefore,

respondent's determination is sustained.
 - 430 -

Issue 14. Whether the Kanters Are Entitled to a Loss From
Computer Leasing Transactions Involving Equitec for 1983 and 1984

OPINION

The Kanters claimed on their Federal income tax returns for

1983 and 1984 losses of $83,333 and $161,727, respectively, from

computer leasing transactions involving Equitec.

In notices of deficiency for 1983 and 1984, respondent

disallowed the losses. The Kanters introduced no evidence at

trial on this issue. They failed to carry their burden of proof.

Accordingly, we sustain respondent's determination.

Issue 15. Whether the Kanters Are Entitled to Investment
Interest Expense Deductions for 1981

OPINION

In the notice of deficiency for 1981, respondent determined

that the Kanters were not entitled to deduct claimed investment

interest expenses from K&D Associates, SLG Partners, and GLS

Associates in the amounts of $21,521, $23,292, and $45,095,

respectively. SLG Partners, GLS Associates, and K&D Associates

were purportedly engaged in the business of purchasing and

leasing computer equipment. The Kanters claimed deductions for

investment interest expenses from those entities in 1981.

The Kanters introduced no evidence on this issue. Therefore,

respondent's determination is sustained.
 - 431 -

Issue 16. Whether the Kanters Are Entitled to an Investment Tax
Credit Carryover for 1978

OPINION

On their 1978 income tax return, the Kanters claimed a

$120,566 investment tax credit carryover, which respondent

disallowed in the notice of deficiency.

The Kanters contend that their entitlement to the 1978

investment tax credit carryover is purely "computational" under

Rule 155. The Kanters assert, in pertinent part:

The issue of whether Kanter is entitled to a
carryover of investment tax credit from his 1977 year
to his 1978 year is purely computational. The
resolution of this issue is entirely dependent upon the
resolution of Kanter's Tax Court case involving his
1977 year (docket No. 12282-82), which was previously
docketed and decided by this Court. Although
respondent * * * [in proposed findings] states that
petitioners failed to address this issue, that is not
the case. Respondent's counsel stipulated on the
record that petitioners had addressed all of the issues
raised in respondent's notice of deficiency. * * *
Since this issue is purely computational, and
respondent is well aware of the terms of the resolution
of Kanter's 1977 tax liability, the amount of the
carryover from 1977 to 1978 will be addressed in the
eventual Rule 155 proceeding in this matter, and need
not be addressed by the Court at this time.

The "stipulation" referred to is the discussion that took place

between the Court, petitioners' counsel, and the supervisor of

respondent's counsel concerning the parties' settlement of a

number of other adjustments from the years in issue.

Respondent, on the other hand, contends that Kanter failed

to carry his burden of proof under Rule 142(a).
 - 432 -

The Court agrees with Kanter on this issue. The Kanters'

1977 tax year was the subject of docket No. 12282-82 before this

Court, in which a stipulated decision was entered on March 12,

1991. That decision was based upon a Stipulation of Settled

Issues which was filed with the Court. The Stipulation of

Settled Issues provided as follows:

Solely for the purpose of narrowing the issues in
[docket no. 12282-82], the Petitioner * * * and the
Respondent have settled issues relating to the
Petitioner's direct or indirect investment in one or
more of the following partnerships, namely, Ambassador
Associates, Empire Properties, Shelburne Associates,
Whitehall Associates, Balmoral Associates, Drake
Associates, FF Associates, Park Lane Associates and
Warwick Associates on the following basis to the extent
applicable to the year(s) before the Court in this
case:

1. Except as provided in this agreement, no item
of income, gain, loss, deduction or credit arising from
the Petitioner's interest in the partnership, shall be
realized and recognized in any taxable year. It is
understood by the parties that this agreement does not
apply to items of income, gain, loss, deduction or
credit from Empire Properties' investment in NST
Investors.

2. The Petitioner's total cash investment
actually or constructively paid shall be allowable as
an ordinary deduction in three equal parts over three
successive years starting with the initial year for
which the Petitioner first claimed a partnership
deduction, provided that the Petitioner includes in
income any cash constructively received with respect to
such contribution in the year of such constructive
receipt.

3. All partnership distributions from the
partnership to the Petitioner shall be includable as
ordinary income in the year of receipt.
 - 433 -

4. In the event the Petitioner is contractually
required, by the terms of the original Partnership
Agreement, to make any additional cash contribution in
a year ending subsequent to the date of this agreement,
the Petitioner shall receive an ordinary deduction for
any such cash contribution in the year paid.

5. Tentative investment credit will be allowed
with respect to the partnership, based on qualified
investment equal to the Petitioner's partnership
percentage times two-thirds times the qualified basis
of the partnership as set forth in Exhibit A, which is
attached hereto and incorporated herein by reference.
No other investment credit from the partnership will be
allowed.

6. If any investment credit was claimed by the
Petitioner which is not allowable under paragraph 5.
for any year(s) which was not disallowed by the
Internal Revenue Service and for which the statute of
limitations would bar assessment, the amount of said
credit will be added to the corrected tax in the first
open year.

7. The petitioner's allocable share of any income
from the partnership attributable to the repayment of
the partnership's recourse and non-recourse liabilities
(non-cash income), shall not be includable in income.
In addition, the Petitioner will not realize any income
as a result of the forgiveness of, or other release of
the related recourse and non-recourse liabilities. If
any such non-cash income was reported by the Petitioner
in any year, then a deduction shall be allowed in that
amount. If such deduction is with respect to a year
for which refunds are barred by reason of the statute
of limitations, such deduction will be allowable in the
first open year.

8. If any losses or deductions attributable to
the partnership were claimed by the Petitioner for any
year(s) which were not disallowed by the Internal
Revenue Service and for which the statute of
limitations would bar assessment, the deduction
allowable pursuant to paragraph 2. will be reduced,
starting with the initial contribution year, by the
amount of loss reported for years closed by the statute
of limitations.
 - 434 -

9. The Petitioner will not be liable for
additional interest under section 6621(c), formerly
(d), penalties or additions to the tax attributable to
the Petitioner's claimed partnership deductions.

10. The parties agree that this stipulation of
settled issues shall not constitute a settlement
agreement for years that are not before the Court in
this case.

Paragraphs 5 and 6 of the Stipulation of Settled Issues

addressed an investment credit. Although the decision and the

Stipulation of Settled Issues did not specify the dollar amount

of the credit to be carried forward to Kanter's 1978 return, the

Court is satisfied that the provisions of the stipulated decision

entered in docket No. 12282-82 permit Kanter to carry forward to

his 1978 year any investment credit allowed for 1977 that was not

utilized to offset 1977 taxes. Accordingly, the Court holds that

the Kanters' entitlement to an investment credit carryover for

1978 is to be taken into account in the Rule 155 computation to

the extent of any carryover from the Kanters' 1977 tax year.

Issue 17. Whether the Kanters Are Entitled to an Interest
Deduction for 1986

OPINION

In the notice of deficiency for 1986, respondent determined

that the Kanters were not entitled to deduct interest expenses

claimed on their Federal income tax return in the amount of

$50,380. The Kanters introduced no evidence on this issue. The

burden of proof was on them and, since no evidence was presented,

respondent's determination is sustained.
 - 435 -

Issue 18. Whether the Kanters Received Unreported Interest
Income from a Bank in 1988

OPINION

In the notice of deficiency for 1988, respondent determined

that the Kanters failed to report $349 interest income from

Merchants Bank and Trust Co.

Kanter's general ledger and audit file for 1988 do not show

that he received interest income from the Merchants Bank and

Trust Co. in 1988. He also testified that no interest was

received from Merchants Bank. There is no evidence that a Form

1099 was issued by Merchants Bank to the Kanters. On this record

we hold for the Kanters.

Issue 19. Whether Kanter Is Entitled to a Business Loss
Deduction in 1980 in Connection With the Sale of a Painting

FINDINGS OF FACT

The Kanters claimed a deduction of $104,231 on Schedule C of

their Federal income tax return for 1980. This deduction arose

out of a transaction involving a painting of George Washington

which was believed to be by the famous artist John Trumbull (the

painting). The painting was located in England. One of the

clients of Kanter's law practice, Richard Feigan (Feigan), was

interested in purchasing the painting but did not have the

resources to do so. Feigan contacted Kanter for Kanter's

assistance in directing him, Feigan, to someone who might be

interested in the painting and who could advance funds for its
 - 436 -

purchase. Kanter directed Feigan to another of his clients, a

Mr. Rappaport (Rappaport), who lived in Switzerland. Feigan and

Rapport thereafter agreed to a joint venture between them and,

through funds advanced by Rappaport, the painting was purchased.

After the purchase, it was discovered that the painting was not

by John Trumbull, and the seller agreed to a rescission of the

sale. The seller paid back to the joint venture the amount of

the selling price, but in British currency. That currency had

substantially declined in value against the U.S. dollar. A

dispute arose between Feigan and Rappaport. Rappaport insisted

that he be returned the full value, in U.S. dollars, of the funds

he had advanced, and Feigan, on the other hand, refused to do so.

Kanter was drawn into the dispute ostensibly because of the role

he had played in putting Feigan and Rappaport together. At

Kanter's urging, Feigan agreed to make Rappaport whole, and

Kanter contributed $104,231 toward the cause. Kanter claimed

this amount as a trade or business expense on his 1980 income tax

return, which respondent disallowed.

Kanter was not contacted by Feigan for legal services or

legal advice, nor was it contemplated that Kanter would be paid

for his services. Kanter was assisting two clients and friends

in a matter unrelated to Kanter's law practice or his activities

as a lawyer. There were no legal services provided by Kanter.

Kanter was not a party to the joint venture between Feigan and
 - 437 -

Rappaport and provided no financing to the venture. Kanter would

not share economically in the exploitation of the painting.

OPINION

Section 162 allows a deduction for all ordinary and

necessary expenses paid or incurred in carrying on a trade or

business. Expenses paid for or on behalf of another are not

deductible. A voluntary assumption of liability is

nondeductible. Polak's Frutal Works, Inc. v. United States, 176

F. Supp. 521 (S.D.N.Y. 1959), affd. 281 F.2d 261 (2d Cir. 1960).

Obligations which do not grow out of a taxpayer's own business

but which are personal in nature are nondeductible. Family

Group, Inc. v. Commissioner, 59 T.C. 660 (1973).

Although Kanter acknowledged that during 1980 he was

practicing law on a full-time basis and was not in the business

of buying and selling art, he contends that he was engaged in the

business of assisting other individuals to locate financing for

investments. He asserts that he "was in the trade or business of

locating financing for investments, whether the investments be in

real estate, securities, or works of art". Thus Kanter argued

that the $104,231 was an ordinary and necessary expense of his

investment financing business and was properly deductible by him.

Alternatively, he contended that, even if the activity was not a

trade or business, a deduction should be allowed under section

212.
 - 438 -

Respondent, on the other hand, argued that the $104,231 was

not an ordinary or necessary business expense but represented a

voluntary expenditure by Kanter on behalf of a third party, which

Kanter was under no legal obligation to make. In addition,

respondent maintained the payment was not deductible under

section 212 because the painting venture was not an activity

Kanter undertook for profit.

We agree with respondent. Kanter was principally engaged in

the practice of tax law. He acted as an intermediary between two

clients in arranging the purchase and sale of a purported

authentic painting of George Washington. He did not provide

financing for the transaction. The purchase was rescinded after

it was discovered the painting was not authentic. The amount

paid by Kanter was to reimburse Rappaport on the loss Rappaport

sustained on the amount that was refunded to him arising from the

devalued British currency.

There is no evidence that Rappaport required Kanter to

perform due diligence on this venture. Kanter testified that

both Feigan and Rappaport were friends of his, and he merely

introduced Rappaport to Feigan to consummate the transaction.

There was no agreement or contract that Kanter was to be paid for

his services either in the acquisition of the funds for the

initial purchase of the painting, in the exploitation of the

painting had the sale not been rescinded, or for Kanter's efforts
 - 439 -

in resolving the dispute between Feigan and Rappaport when the

deal failed.

The loss which Kanter sustained resulted from his desire to

protect his personal relationship with his friends Feigan and

Rappaport and was not an ordinary or necessary expense of his

legal practice or to protect his business reputation because no

business of his own was conducted or consummated by this

transaction.

Respondent correctly contends that Kanter's payment of

amounts to settle a putative dispute had no relation to his legal

practice. Kanter's involvement constituted personal rather than

professional conduct, and, thus, the expenditure is

nondeductible. Kanter had no money invested in the deal. He

merely acted as a broker for his clients, who were also his

friends. He was clearly not engaged in a separate business of

selling artwork. See McDonald v. Commissioner, 592 F.2d 635 (2d

Cir. 1978).

In Cochrane v. Commissioner, 23 B.T.A. 202 (1931), cited by

Kanter, the attorney who reimbursed his clients had provided

legal services to them. By contrast, Kanter did not perform any

legal services in connection with the Feigan venture. The only

proof that he made the payment to protect himself from a possible

lawsuit and the exposure of litigation was his own self-serving

and uncorroborated testimony.
 - 440 -

Kanter did not testify that Rappaport would include him as a

party in any litigation. He failed to present any proof of

damage to his business reputation. If anything, Kanter was

protecting his personal reputation, not his business reputation.

He reimbursed Rappaport for a portion of the losses as an

accommodation to two friends, after a deal he proffered failed.

Kanter argues that the cases of Milbank v. Commissioner, 51

T.C. 805 (1969), and Pepper v. Commissioner, 36 T.C. 886 (1961),

support the deduction claimed by him. Contrary to the facts

here, the taxpayer in Milbank was in the investment banking

business and consummated a loan transaction. When the

transaction failed, the taxpayer argued he was a guarantor of the

loan, which payment had a proximate relationship to his trade or

business as a financier or investment banker. Kanter, in

contrast, is not a banker or financier. In any event, he did not

show that he entered into this transaction with the intent of

making a profit. Kanter is a lawyer who was consulted on various

business matters. Kanter was not engaged in the business of

selling valuable artwork. He was not paid to find the investor

but merely directed his friend to another friend. Contrary to

the holding in Milbank, Kanter was not protecting his reputation

as a lawyer or investor but merely protecting his friendship with

Feigan and Rappaport.
 - 441 -

Unlike the taxpayer in Pepper v. Commissioner, supra, Kanter

did not actively solicit financing for his friend Feigan, nor did

he or his law firm receive fees for services rendered in the

transaction. He merely served as an intermediary to introduce

Feigan to another friend, Rappaport. There was no written

contract between Feigan and Kanter for the sharing of profits.

Accordingly, respondent's determination with respect to this

issue is sustained. We hold that Kanter is not entitled to the

claimed business loss deduction. We also hold that, because

Kanter received no fees and no contract existed therefor, the

expenditure did not bear a reasonable and proximate relationship

to the production of income. Thus, it is not deductible under

section 212.

Issue 20. Whether the Kanters Are Entitled To Deduct a Claimed
Charitable Contribution of $15,000 to the Jewish United Fund in
1982

FINDINGS OF FACT

On their income tax return for 1982, the Kanters listed

$25,182 in charitable contributions, which they were unable to

deduct on Schedule A as itemized deductions for the reason that

the return showed negative gross income of $287,536. The

limitation provisions of section 170(b) precluded any deduction

for charitable contributions. In the notice of deficiency for

1982, the various adjustments by respondent resulted in the

Kanter's having adjusted gross income for 1982 in such amount
 - 442 -

that the limitation provision of section 170(b) was not

applicable. Respondent allowed the Kanters a deduction for the

charitable contributions listed on their return except a

contribution of $15,000 to the Jewish United Fund (JUF).

On or about December 17, 1982, Holding Co., by Meyers,

president, executed a promissory note dated December 17, 1982,

payable to Kanter in the face amount of $15,000 due on March 1,

1983, with interest at 12 percent per annum. Respondent has not

disputed that this indebtedness is bona fide.

On December 27, 1982, Holding Co., by Meyers, president,

sent a letter to JUF enclosing the Holding Co. note and Kanter's

pledge card to JUF for $15,000. This letter stated in pertinent

part that Holding Co. "will pay its note to Kanter who will, in

turn, see to providing these funds to JUF". In a letter to

Kanter dated December 30, 1982, JUF acknowledged its receipt of

the Holding Co. 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, Holding Co. paid to Kanter the $15,000

face amount due on the Holding Co. note plus interest of $370.

Kanter reported the interest paid on the Holding Co. note on his

income tax return for 1983.
 - 443 -

On February 28, 1983, Kanter paid $15,000 to the JUF by a

check on his personal bank account. Neither Holding Co. nor

Kanter paid any interest on the Holding Co. note to JUF.

Kanter did not establish that he endorsed the Holding Co.

note over to JUF in 1982. Kanter contends he is entitled to a

1982 charitable contribution deduction because the $15,000 note

was delivered to JUF during 1982.

OPINION

Section 170(a) generally provides that a deduction is

allowed for charitable contributions, payment of which is made

within the taxable year. Charitable contributions can be made in

the form of cash or property, including third party promissory

notes. See MacKay v. United States, 503 F.2d 591 (10th Cir.

1974), a case distinguishable from the facts herein.

The Kanters contend that they are entitled to a charitable

contribution deduction for 1982 of at least $14,700, which they

maintain was the Holding Co. promissory note's fair market value

on the date of its contribution to JUF in December 1982. They

assert that "While a small discount for the fact that the note

was not to be paid until several months after the date of

contribution is perhaps required, there is no basis for

disallowing the entire contribution”. The Kanters submit that,

given the interest rates at the time (as reflected in the IRS's

applicable Federal rates, as well as the 12-percent interest rate
 - 444 -

set in the note itself), the 1982 deduction should be discounted

no more than $300.

To the contrary, respondent contends that the Kanters are

not entitled to the claimed charitable deduction for 1982 on

alternative grounds because (1) there was no endorsement of the

Holding Co. promissory note by Kanter to JUF, or (2) the Kanters

failed to establish the note's fair market value on the date of

its purported contribution to JUF in late 1982. On brief,

respondent concedes that the Kanters are entitled to a charitable

contribution deduction for 1983 for the $15,000 because Kanter

paid that amount to JUF in 1983, subject to the adjusted gross

income limitations of section 170(b) for 1983.

Ordinarily, a charitable contribution is made at the time

delivery is effected. If a taxpayer unconditionally delivers or

mails a properly endorsed stock certificate to a charitable donee

or the donee's agent, the gift is completed on the date of

delivery. See sec. 1.170A-1(b), Income Tax Regs. Respondent

argues that, like a stock certificate, a promissory note is

delivered to a donee only after it has been properly endorsed and

unconditionally delivered to the donee. Here Kanter failed to

establish that he endorsed the Holding Co. promissory note over

to JUF. As evidence that he contributed the note to JUF, Kanter

introduced a copy of only the front page of the note; a copy of

his pledge card; a copy of a Holding Co. letter reciting delivery
 - 445 -

of the note to JUF; a letter from JUF acknowledging receipt of

the note as a charitable contribution; and his testimony that he

"transferred" the note to JUF. At best, this evidence

establishes that Kanter delivered during 1982 an unendorsed note

to JUF and a promise to pay his 1982 pledge to JUF on March 1,

1983. As indicated in Holding Co.'s letter, dated December 27,

1982, direct payment of the Holding Co. note to JUF was never

contemplated, which would have been the case if Kanter had

properly endorsed the Holding Co. note over to JUF. Rather,

payment of the note was to be made to Kanter who in turn would

pay JUF. Kanter failed to produce the original promissory note

or even a copy of the reverse side of the note that would

indicate whether the note was properly endorsed over to JUF.

We believe respondent's contention that Kanter failed to

contribute the note to JUF is supported by the evidence. When

the note became due in 1983, Holding Co. paid Kanter, rather than

JUF, the $15,000 face amount of the note plus $370 interest, and

Kanter, in 1983, paid $15,000 and no interest to JUF. If a

proper legal transfer of the note had been made so that JUF

became the true owner of the note and Kanter retained no dominion

or control, Holding Co. would have paid JUF directly. More

importantly, if Kanter had legally transferred the note to JUF in

December 1982, and no longer had any dominion or control over it

thereafter, then JUF, not Kanter, would have been entitled to the
 - 446 -

interest due on the note. The fact that Holding Co. paid the

principal and interest to Kanter, rather than JUF, is additional

proof that Kanter never legally transferred the Holding Co. note

to JUF. Therefore, we hold that Kanter is not entitled to a

deduction for the claimed contribution to JUF for 1982, but that

he is entitled to a charitable contribution deduction for 1983

for the $15,000 paid to JUF that year, subject to the adjusted

gross income limitations of section 170(b). See Petty v.

Commissioner, 40 T.C. 521, 524-525 (1963); compare Christensen v.

Commissioner, 40 T.C. 563, 574-577 (1963).

Issue 21. Whether the Kanters Are Entitled to Claimed Capital
Gains and Losses for 1987

FINDINGS OF FACT

On their Federal income tax return for 1987, the Kanters

reported the following capital gains and losses:
 - 447 -

Short-Term Capital Gains and Losses

Gross
Date Date Sale Gain
Description Acquired Sold Price Basis or Loss
SHS Brajdas Corp. 4/02/87 5/29/87 $1,780 $1,304 $476
SHS Flex Comp. 5/29/87 10/19/87 40,000 53,600 (13,600)
Rooney Pace Bond 5/29/87 12/29/87 10 5,000 (4,990)
SHS Elec. Missile 5/29/87 10/19/87 41,250 30,000 11,250
Total 83,040 89,904 (6,864)

Long-Term Capital Gains and Losses

Gross
Date Date Sale Gain
Description Acquired Sold Price Basis or Loss
SHS Sun Resorts 6/20/84 12/03/87 $1,300 $250 $1,050
SHS Newport Pharm. 82 12/21/87 84,380 361,143 (276,763)
SHS I.H.O.G. 10/07/86 12/21/87 1 5,000 (4,999)
SHS Lezak Group 3/29/85 12/21/87 –- 1 (1)
N/R Victorian Vill. 85 12/22/87 27,949 311,878 (283,929)
N/R S. Block 1/19/87 12/22/87 1 23,356 (23,355)
N/R Tanglewood 12/15/86 12/22/87 100 10,000 (9,900)
N/R R. Trust 78 12/22/87 1 53,000 (52,999)
N/R D. Anderson 3/31/87 12/22/87 1 195 (194)
N/R Arlington Corp. 3/31/87 12/22/87 1 11,792 (11,791)
N/R Pam Osowski 3/31/87 12/22/87 1 16,625 (16,624)
N/R Classic Cust. 3/31/87 12/22/87 5,000 79,366 (74,366)
Red Pond Beach 1/02/69 12/31/87 1,896 -- 1,896
BK Eagle Prtshp 7/05/72 12/31/87 -- 1 (1)
BK Freedom Prtshp 9/01/73 12/31/87 -- 1 (1)
BK Lioness Prtshp 8/11/72 12/31/87 -- 1 (1)
Total 120,631 872,609 (751,978)
 - 448 -

In the notice of deficiency for 1987, respondent disallowed

the claimed basis in each of the assets reported sold. In

addition, respondent disallowed the claimed losses on the grounds

that the sales were to related taxpayers, the sales were not at

arm's length, were not entered into for profit, and the sales

prices were not at fair market value.52 Some of the sales were

to MAF, Inc. (MAF), and others were to Windy City, Inc. (Windy

City), except for the Rooney Pace bond, which was sold to Mallin

and the Brajdas Corp. stock, which was sold to an unrelated third

party. The Eagle, Freedom, and Lioness Partnership interests

were not sold to anyone. Kanter claimed a loss for these

interests on the basis of abandonment.

MAF was a wholly owned subsidiary of Computer Placement

Services, Inc. (CPS). The record does not show who legally or

beneficially owned CPS. MAF had no offices of its own and

operated out of the accounting firm office of Morrison, MAF's

president. Morrison, a certified public accountant, was a

longtime friend of Kanter and had accounting clients who were

also clients of Kanter. Freeman, who was IRA's president until

about 1988, had asked Morrison to serve as MAF's president.

Morrison received no compensation as MAF's president. MAF

52
In a Stipulation of Settlement filed by the parties,
respondent conceded adjustments relating to Sun Resorts and the
Lezak Group adjustments. Respondent, on brief, further conceded
the Newport Pharmaceutical and D. Anderson adjustments.
 - 449 -

purchased the notes in question as a favor to Kanter. Kanter

sold the notes to MAF to enable him to realize a loss for tax

purposes. Kanter's testimony at trial as to the reason he "sold"

the notes (as well as the other securities at issue) is

paraphrased in his brief, as follows:

Throughout trial, Kanter candidly admitted that the
purpose of the asset sales was to "establish" a loss
for tax purposes, because of the traditional practice
of Respondent's agents to routinely propose to disallow
Section 165 or Section 166 deductions claimed in IRA's
or Kanter's tax returns.

Thus, by selling the various assets for a nominal amount, Kanter

was attempting to realize a loss by means of a sale or exchange

rather than as a bad debt or worthless security deduction. MAF

neither inquired into nor independently ascertained the value of

the purchased promissory notes. MAF did not look into or

consider a particular note's collectibility or the

creditworthiness of its maker or obligor. Specifically, during

1987, MAF purchased the Victorian Village and S. Block notes from

Kanter for $27,949 and $1, respectively, as an accommodation to

Kanter. After 1987 and up to the trial, Morrison continued as

president of MAF, although, since 1989, MAF has not been active

and has not conducted any business.

At all times relevant to this litigation, Windy City was a

corporation solely owned by the 25 Bea Ritch Trusts. Joel

Kanter, Kanter's son, was the president of Windy City. Weisgal,

a longtime friend and business associate of Kanter, was the
 - 450 -

trustee of each of the Bea Ritch Trusts. Specifically, the

assets sold to Windy City were all of the other assets described

in the table above except the Rooney Pace bond, which was sold to

Mallin, and the Brajdas Corp. stock, which was sold to an

unrelated third party.

Mallin was a former law partner of Kanter's who served on

the board of directors of Cedilla. Mallin was extensively

involved in equipment sale/leaseback transactions involving IRA

and Cedilla. Those transactions are the subject of discussion in

Issue 22. As noted above, Mallin purchased the Rooney Pace bond.

For the most part, the assets at issue were reflected as

acquisitions by Kanter that were paid for out of Kanter's special

E account with Administration Co. As of December 31, 1986,

Kanter's special E account balance with Administration Co. was a

negative $79,283.

The Brajdas Corp. stock was purchased on April 20, 1987, for

$1,300 in the exercise of a warrant. Kanter sold the stock to an

unrelated party on May 29, 1987, for $1,780, realizing a gain of

$476. The record does not reflect the acquisition history of the

Flexible Computer stock, the Rooney Pace bond, or the Electronic

Missile stock.

The IHOG stock was held by the Nominee Corp., a corporation

which apparently held assets for the equitable and beneficial

interest of Kanter. It appears from the record that IHOG was not
 - 451 -

wholly owned by the Nominee Corp. The IHOG stock at issue was

acquired on October 7, 1986, through a check issued by

Administration Co. out of Kanter's account, payable to IHOG, in

the amount of $10,000. On February 11, 1987, IHOG paid $5,000 to

the Nominee Corp. as a "return of capital". Thus, Kanter claimed

a basis of $5,000 in this stock. In a letter accompanying the

payment of the $5,000 to the Nominee Corp. it was stated that

efforts were continuing to pursue the further development and

sales of IHOG's product, the nature of which was not indicated in

the letter.

Funds were advanced to Victorian Village from the

Administration Co. special E Account, and Victorian Village

issued notes payable to Nominee Corp.

Kanter issued a check to S. Block dated February 14, 1984,

in the amount of $5,000, bearing the notation "loan". Block

executed a $16,130.53 note to Kanter, dated July 1, 1985.

Administration Co. special E Account issued a check to Block in

the amount of $3,000, dated December 12, 1984. Block executed a

$10,000 note to Administrative Enterprises special E Account,

dated January 21, 1987. Although the record is not at all clear,

there is apparently no dispute that the balance due on the Block

note or notes was $23,356 on the date of sale, December 22, 1987.

The Tanglewood note receivable is the same note receivable

from Tanglewood to IRA in the amount of $350,000 that Kanter
 - 452 -

purportedly bought from IRA on December 1, 1985 for $10,000.

Kanter paid no cash for this note. His purchase of the note from

IRA was accomplished through an adjusting journal entry on the

books of IRA.

Weisgal was trustee of the R Trust. The R Trust issued a

$1,000 note to Holding Co. dated August 29, 1978; a $20,000 note

to Holding Co. dated November 21, 1979; and a $31,500 note to

Kanter dated February 2, 1978. Through Administration Co.

bookkeeping entries, Kanter acquired the notes receivable

totaling $21,000 due from the R Trust to Holding Co. on August

29, 1986. Kanter paid no cash for this note, but his amount due

to Administration Co. was increased by $21,000. In 1988, in

exchange for $10,000 of its $64,000 note payable to HELO, Zeus

acquired a $10,000 note receivable of the R Trust from HELO.

Administration Co. wire-transferred $15,000 to Virginia

Arlington F/C Arlington Carpentry, Inc. (Arlington), on November

27, 1985. Administration Co. filed a financing statement that

covered Arlington's equipment and receivables. Administration

Co. wired the funds to Arlington at Kanter's direction. Kanter

did not know the individual at the head of Arlington. However,

that individual was a friend of Kanter's son, Joel, who was

having some work done by Arlington. Joel asked Kanter to send

the money to Arlington, and Kanter agreed.
 - 453 -

Prior to the years in question, Pamela Osowski (Osowski) was

Kanter's secretary. At some time, she also worked for Film

Writers Corp. Administration Co. transferred money to Osowski

during 1984 and 1985 by check and wire transfer. The checks

contained the notation "loan". A document entitled "WIRE

TRANSFER RECORD" also contained the notation "loan", but did not

indicate from what account the alleged wire transfer was made.

Kanter acquired the Osowski note from Administration Co. on March

31, 1987, for $16,625.

Classic Custom Furniture was owned by Meyers' husband.

Administration Co. transferred funds by check and wire transfer

to the account of Classic during 1984 and 1985, and Classic

transferred funds by check to Administration Co. during 1984

through 1987.

OPINION

I. Legal Principles

A. Bona Fides of a Transaction for Tax Purposes

It is a well-settled principle of tax law that labels or

classifications affixed by the parties to a transaction do not

control for tax purposes. If the form of a transaction reflects

its substance, and the sole purpose of the transaction is not tax

avoidance, generally the transaction will be recognized for

Federal tax purposes. See Gregory v. Helvering, 293 U.S. 465

(1935). A transaction that has genuine economic substance and
 - 454 -

conforms with business realities will be respected for tax

purposes. See Frank Lyon Co. v. United States, 435 U.S. 561,

584-585 (1978).

B. Section 267

Section 267 and its predecessors were enacted to correct

what Congress considered the abusive and frequently employed

practice of creating losses for purposes of avoiding income taxes

through transactions between related persons and groups. Because

of the identity of economic interests of such parties and the

control taxpayers had over the persons or entities involved, the

transfers were usually not thought to result in economically

genuine realization of loss. See McWilliams v. Commissioner, 331

U.S. 694, 699 (1947); H. Rept. 704, 73d Cong., 2d Sess., 1939-1

C.B. (Part 2) 554, 571. To prevent tax avoidance, Congress, in

section 267 and its statutory predecessors, denied deductions for

losses on all sales or exchanges between specified related

persons, regardless of such persons' subjective intent. Thus,

where section 267 is applicable, it is immaterial whether the

particular transaction involved is a bona fide, arm's-length

transaction. See McWilliams v. Commissioner, supra.

Generally, section 267(a) provides that no deduction shall

be allowed for any loss realized from the sale or exchange of

property between related persons or entities. Included among the

relationships are transactions between members of a family and
 - 455 -

transactions between an individual and a corporation in which

such individual owns, directly or indirectly, more than 50

percent in value of the outstanding stock. Other provisions of

the statute define "related persons", and other rules define what

constitutes direct and indirect ownership of corporate stock.

In Hickman v. Commissioner, T.C. Memo. 1972-208, this Court

stated that section 267(b)(2) and (c)(1) "contemplate valuing the

stock interest owned by or for an individual, whether outright or

in trust for his benefit, without detracting from the value of

the stock because it is indirectly owned rather than directly

owned. If the section is to apply equally to indirect and direct

ownership, this must be the case."

C. Abandonment Loss

To be entitled to an abandonment loss under section 165, a

taxpayer must show: (1) An intention on the part of the owner to

abandon the asset, and (2) an affirmative act of abandonment.

See Citron v. Commissioner, 97 T.C. 200, 208-209 (1991), and

cases cited therein. An affirmative act to abandon must be

ascertained from all the facts and circumstances, see United Cal.

Bank v. Commissioner, 41 T.C. 437, 451 (1964), affd. per curiam

340 F.2d 320 (9th Cir. 1965), and "the Tax Court [is] entitled to

look beyond the taxpayer's formal characterization", Laport v.

Commissioner, 671 F.2d 1028, 1032 (7th Cir. 1982), affg. T.C.

Memo. 1980-355. "The mere intention alone to abandon is not, nor
 - 456 -

is non-use alone, sufficient to accomplish abandonment." Beus v.

Commissioner, 261 F.2d 176, 180 (9th Cir. 1958), affg. 28 T.C.

1133 (1957). Abandonment of a partnership interest should be

accompanied by some express manifestation, and the need to

manifestly express the intent to abandon is especially important.

See Citron v. Commissioner, supra at 209-210.

II. The Parties' Contentions

Kanter contends on brief:

respondent appeared to concede during trial that the
sole remaining grounds supporting respondent's
disallowance of the bad debt and loss deductions were:

(i) Whether funds disbursed from the
Administration Co. "Special E" account or from other
nominee accounts in fact belonged to Kanter * * * (the
"Special E Issue"); and

(ii) Whether assets which were written-off or sold
were in fact "worthless".

* * * * * * *

Petitioners believe that respondent's concessions
should be interpreted as follows:

(i) where an asset with a substantial cost basis
was sold for $1, $10, or for substantial consideration,
the remaining issue is whether the asset was worth no
more than the selling price; and

(ii) where an asset was written-off as a bad debt
or worthless security, the remaining issue is whether
the asset was worthless.

Kanter argues further that he substantiated and is entitled to

the basis and capital losses claimed on his 1987 Federal income

tax return. Alternatively, he argues that, if the Court holds
 - 457 -

that either (1) some of the transactions are not bona fide

transactions for tax purposes, or (2) no loss is allowable

because the sales were to a related party, he is still entitled

to deductions for worthlessness or partial worthlessness with

respect to the assets involved. He also asserts that he is

entitled to deductions under section 165 for abandonment losses

with respect to the BK Eagle, BK Freedom, and BK Lioness

partnership interests.

To the contrary, respondent contends that, except for the

conceded capital losses, Kanter failed to meet his burden of

proof with respect to the determinations in the notice of

deficiency. Specifically, respondent argues that (1) Kanter did

not substantiate the claimed bases in the assets sold; (2) the

sales were to related buyers; (3) the sales were not arm's-length

transactions; or (4) the transactions lacked substance.

III. Analysis

To begin with, the Court disagrees with Kanter's contention

that certain statements by respondent's counsel during the trial

constituted "concessions" whereby respondent abandoned or waived

some of the grounds in the notice of deficiency disallowing the

losses the Kanters claimed. In our view, Kanter is reading the

statements of respondent's counsel out of their proper context.

These statements were made during discussions between the Court

and respondent's counsel as to some of the legal issues
 - 458 -

pertaining to these and other similar adjustments in these cases.

The Court did not understand respondent's counsel, during the

trial, to have abandoned or conceded certain grounds in the

notice of deficiency disallowing the Kanters' claimed loss

deductions for 1987, including the grounds that the transactions

involved (1) were not bona fide transactions, or (2) were sales

made to related parties. Indeed, the Court finds the

"concession" argument surprising considering questions the Court

raised during Kanter's testimony. In its questioning, the Court

indicated that neither respondent nor the Court was necessarily

required for tax purposes to respect, as bona fide, transactions

labeled as "sales" that Kanter had arranged in order to claim

losses.

As to the adjusted bases the Kanters claimed, which

respondent challenged particularly in those situations where a

gain was reported, it was substantiated that Kanter had such

basis in each of the individual assets. As indicated previously,

funds from the Administration Co. special E and PSAC special E

accounts were Kanter's funds. In some instances, Kanter

testified that, although certain assets were acquired by him

through various nominees, the funds expended in the assets'

acquisition were payments that he made. In other instances,

Kanter paid for acquired assets by reducing the amount of

existing debts owed to him by the seller. Consequently, the
 - 459 -

Court rejects the basis issue raised by respondent and holds that

the Kanters realized short-term capital gains of $476 and $11,250

from Kanter's respective sales of Brajdas shares and Electronic

Missile shares.

With respect to the Rooney Pace bond sale to Mallin and the

two notes sold to MAF (the Victorian Village and Sam Block

notes), we are not satisfied that these were bona fide sales. In

our view, MAF was not acting at arm's length with Kanter in these

two note transactions. We have similar doubts with respect to

the arm's-length nature of the Rooney Pace bond sold to Mallin

because Kanter originally acquired the bond for $5,000 on May 29,

1987, but later "sold" the bond to Mallin for $10 on December 29,

1987.

More importantly, the totality of the evidence, including

Kanter's admission that he reported the transactions as sales

solely for the purposes of avoiding the audit process and the

generally more onerous task of establishing worthlessness

satisfies the Court that the transactions were not bona fide

sales and were not at arm’s length.53 Among other things, the

Court doubts that MAF and other accommodating parties ultimately

53
Besides the transactions at issue here, IRA also "sold" to
MAF the promissory notes of Ballard and Lisle's respective
grantor trusts, which trusts had invested in movie shelters. As
of the time these trust note transactions took place, the trusts'
movie investments had proved to be unsuccessful, so that for all
practical purposes the trusts held no assets.
 - 460 -

parted with and were actually out of pocket for the funds they

purportedly expended in these "transactions"; it is inferable

that the purported amounts, if paid for more than a nominal

amount, were returned to them in a circular fashion.54 In these

circumstances we conclude that Kanter failed to meet his burden

of proving that the Rooney Pace bond transaction with Mallin and

the two note transactions with MAF were bona fide transactions.

Consequently, we sustain respondent's determinations that the

Kanters are not entitled to loss deductions with respect to those

transactions in 1987. These transactions were not at arm’s

length and were not bona fide. See, e.g., Estate of Miller v.

Commissioner, T.C. Memo. 1968-230, affd. 421 F.2d 1405 (4th Cir.

1970).

On brief, Kanter argues that the Victorian Village note sale

to MAF stands on a different footing, because the note was "sold"

54
As stated in the Court's findings, the record does not
reflect who owned Computer Placement Services, the corporation
that owned 100 percent of MAF's stock. Although Kanter testified
that he had no interest in Computer Placement Services (see,
however, the discussion infra on petitioners' failure to
establish the inapplicability of sec. 267 to the Victorian
Village note transaction), he acknowledged performing some legal
work for Computer Placement Services. Moreover, Morrison stated
that MAF had no offices of its own, operated out of his
accounting firm's office, and that Freeman (IRA's president) had
asked Morrison to be MAF's president. Morrison further related
that he is a longtime friend of Kanter, and that he was paid no
compensation by MAF for being MAF's president.
 - 461 -

for more than an insubstantial amount ($27,949).55 In this

regard, he testified how he determined the note's stated purchase

price:

[Petitioner's counsel]: * * * With respect to [the]
Victorian Village [note] * * *, please tell the Court why
that was sold for $27,949 and a loss of $283,929 was taken?
Would you please tell the Court why you would have sold this
note at such a substantial discount?

[Kanter]: Well, at the time, it was my judgment it was
worth no more that the amount that was received. This was a
real estate timeshare project out West. We thought that it
could run very successfully and the units in it were sold on
a timeshare basis effectively.

That did not turn out to be the case, and despite a
series of efforts at refinancing, one of which took place
and the others which did not, the property was at a point--I

55
The Court finds Kanter's arguments with respect to the bona
fides of this transaction and other transactions with MAF
inconsistent and, at times, contradictory. For instance, in
proposed findings on the Victorian Village note transaction,
Kanter, in his opening brief, acknowledges Morrison's (MAF's
president) testimony that MAF purchased various assets from
Kanter as "an accommodation". Yet, on reply brief, he asserts
somewhat differently that Morrison's testimony did not
necessarily refer specifically to the Victorian Village note
transaction. His testimony, it is now asserted, pertained only
to those notes for which MAF "paid" $1. It is argued that "He
did not testify that collectibility of the Victorian Village note
was not a concern * * * [to him] or MAF. Considering the size of
MAF's investment, $27,949, it would be unreasonable to assume, in
the absence of explicit testimony, that collectibility was not an
issue to MAF when acquiring the Victorian Village note." The
Court notes that there was ample opportunity, during the trial,
to clarify Morrison's testimony on this point. No attempt was
made to ask Morrison whether he had examined and inquired into
the Victorian Village note's collectibility. Considering the
fact the Morrison received no compensation for being MAF's
president, the Court does not believe that he did make such an
examination or inquiry. The Court has determined in its findings
that Morrison and MAF failed to examine and consider the
collectibility of the notes "purchased" from Kanter.
 - 462 -

don't recall whether this exact year or when. The property
was in deep trouble. However, I thought because we had a
position with respect to this note, that there might be some
recovery. My judgment was based--as to value was based on
information that I received from the people running the
property, as to what they thought might be the recovery in
the event of a foreclosure sale, or might be earned within a
period of time, and it clearly was my judgment it was worth
no more than that, and that was the price at which it was
sold.

The Court: Now, you don't have any documentary
evidence about bankruptcy or inability of these people to
pay their debts?

[Kanter]: Ultimately the property did get foreclosed.
I don't have any handy, and I don't have extensive
cumulation of documents, because there was no filing that
would offer an opportunity for reorganization. But it was
foreclosed in the end.

Essentially, Kanter is asking the Court to credit his testimony,

accept his judgment as to the note's asserted fair market value,

and hold the note's "sale" to MAF was a bona fide transaction.

We decline to do so in view of Kanter's unreliable testimony and

other credible evidence of record indicating that a number of

Kanter's transactions with MAF were not bona fide transactions.

It appears to us that documentary evidence should have been and

could have been provided by Kanter to corroborate his testimony

in this regard. Thus, we conclude that Kanter failed to meet his

burden of proving that the Victorian Village note transaction was

bona fide. We also conclude that Kanter failed to show that MAF

was not a related party under section 267(b)(2) and (c).

Although Kanter testified that he had no interest in MAF's parent

company, Computer Placement Services, he offered no evidence
 - 463 -

establishing whether he or his family "indirectly" held less than

a 50-percent interest in the parent company. Accordingly, we

sustain respondent's determination that the Kanters are not

entitled to a loss deduction for the Victorian Village note sold

to MAF in 1987.

Similarly, with respect to the Windy City transactions,

involving sales to Windy City of stock in Flexible Computer,

IHOG, and notes owing by Arlington Carpentry, Classic Custom

Furniture, Pam Osowski, R Trust, and Tanglewood, we conclude that

Kanter failed to meet his burden of proof to establish deductible

losses. As a threshold matter, Kanter failed to prove that Windy

City was not a related party under section 267(b)(2) and (c)(2).

We note that some of these transactions were for nominal amounts,

and that the Bea Ritch Trusts (which trusts were established by

Kanter's family) owned all of Windy City's shares. Earlier, in

this opinion, we held that Kanter was the deemed grantor of the

Bea Ritch Trusts during 1987, and the beneficiaries were members

of his family. Therefore, Windy City was clearly a related party

to Kanter. Moreover, Kanter failed to prove that each of the

transactions was bona fide. The named trustee of the 25 BRT

trusts was Weisgal, a longtime friend and business associate of

Kanter. Windy City's president was Joel Kanter, Kanter's son.

For the foregoing reasons, we sustain respondent's determination

that the Kanters are not entitled to loss deductions on these
 - 464 -

transactions in 1987. See also Scully v. United States, 840 F.2d

478 (7th Cir. 1988).

The Court further concludes that Kanter failed to meet his

burden of proving that the Kanters are entitled to abandonment

losses with respect to the BK Eagle, BK Freedom, and BK Lioness

partnership interests. Kanter generally testified that a number

of assets on which the Kanters had claimed capital losses for

1987 were essentially worthless. In our view that is not

sufficient to establish abandonment. Kanter failed to show (1)

an intention on his part to abandon each partnership interest,

and (2) an affirmative act of abandonment with respect to each

partnership interest. See Citron v. Commissioner, 97 T.C. at

209-213. Consequently, we sustain respondent's determination

that the Kanters are not entitled to loss deductions on these

partnership interests for 1987.

The Court also rejects the alternative contention that the

Kanters are entitled to deductions for partial worthlessness of

the promissory notes under section 166(a)(2).56 They made no

56
Although sec. 166(a)(2) provides that a bad debt deduction
for partial worthlessness of a debt may be allowed, certain
requirements must be met. The taxpayer claiming such a deduction
for partial worthlessness generally must have (1) charged off
such portion of the debt for that year, and (2) demonstrated to
the District Director's satisfaction that such portion of the
debt is worthless. See sec. 1.166-3(a), Income Tax Regs.; Austin
Co., Inc. v. Commissioner, 71 T.C. 955, 971 (1979); Findley v.
Commissioner, 25 T.C. 311, 318-319 (1955), affd. per curiam 236
F.2d 959 (3d Cir. 1956); see also Mayer Tank Manufacturing Co.,
(continued...)
 - 465 -

claim for partial worthlessness in their pleadings, nor did they

seek leave to amend their pleadings to raise the issue. The

parties never consented to try such issue during the trial. This

alternative argument, therefore, is not properly before the

Court.

Issue 22. Whether Respondent Correctly Made Adjustments to the
Rental Income, Depreciation, Interest Expense, and Investment Tax
Credits Claimed by Investment Research Associates, Ltd. (IRA) in
Connection with Equipment Leasing Transactions for 1979, 1980,
and 1982 Through 1989

FINDINGS OF FACT

I. Background and Adjustments Made in Deficiency Notices

A. IRA and Cedilla Investment

IRA and its subsidiary Cedilla Invest. (hereinafter

sometimes referred to collectively as IRA) engaged in various

equipment leasing transactions involving the sale and leaseback

of computer and related equipment beginning in 1976 and

continuing through 1987. Although the parties disagree on who

owned the various classes of stock in Cedilla Invest., and it

appears the stock ownership in Cedilla Invest. varied over the

years, the parties agree that for the years at issue, IRA held

directly or indirectly at least 80 percent of Cedilla Invest.'s

(...continued)
Inc. v. Commissioner, 126 F.2d 588 (2d Cir. 1942), affg. a
Memorandum Opinion of this Court. On their 1987 return, the
Kanters claimed no bad debt deductions under sec. 166(a)(2) for
partial worthlessness of these various promissory notes. Rather,
they claimed loss deductions under sec. 165 from their sales of
the notes to other parties.
 - 466 -

voting stock and that Cedilla Invest. was included in IRA's

consolidated tax returns for those years.

Kanter was the attorney for IRA and investment adviser with

respect to its computer leasing transactions. No one employed by

IRA was responsible for negotiating the equipment leasing deals

except Kanter, who assumed responsibility for them. IRA did not

utilize the services of experts in computer equipment in

connection with any of the computer equipment leasing

transactions that were consummated during the years in question.

In notices of deficiency to IRA, respondent determined that

IRA was not entitled to deductions and credits with respect to

various computer equipment leasing transactions during the years

at issue.

Respondent made the following adjustments to IRA's Federal

income tax returns in connection with its equipment leasing

transactions:

Year Rent Income Depreciation Interest Expense

1980 ($830,964) $2,353,776 $1,027,510
1983 (2,581,652) 1,632,456 1,732,404
1984 (2,689,177) 1,743,556 1,628,589
1985 (2,689,177) 1,219,280 1,495,916
1986 2,151,377 1,850,912 701,824
1987 2,587,958 –- --
1988 1,633,794 –- --
1989 1,406,784 –- –

Respondent disallowed the following investment tax credits

claimed by IRA relating to the equipment leasing transactions:
 - 467 -

Year Amount
1979 $46,049
1980 13,778
1983 56,280

Respondent disallowed in full the investment tax credit

carryovers claimed by IRA for 1982 through 1987.

1. Schott

Schott was an officer and director of IRA in 1979. Despite

the fact that IRA's Federal income tax returns indicate that

Schott was a 50-percent owner of IRA, she had no knowledge

regarding her participation in that entity as an equity owner.

Previously, Schott had been an officer of Cedilla Invest.

starting in 1974 or 1975. She served as president of Cedilla

Invest., yet did not know what she did for the company.

Schott executed documents on behalf of Cedilla Invest. with

respect to equipment leasing transactions without knowing who

prepared the documents or the purpose of the documents. She did

not recall negotiating any leasing transactions on behalf of

Cedilla Invest.

2. Mallin

Mallin was asked to be a director of Cedilla Invest. by

Kanter, a friend and former law partner, at a time when Mallin

did not know who owned Cedilla Invest. Mallin was generally not

familiar with IRA or Cedilla Invest. or their officers and

directors.
 - 468 -

Mallin negotiated, promoted, and brokered computer leasing

transactions during the years at issue. His duties in

negotiating, promoting, and brokering leasing transactions did

not include making specific determinations of the values of the

underlying equipment but were limited to personal beliefs of

general values for the purpose of his desire to "comfortably

represent" transactions. These personal beliefs were based

primarily on his review of some industry publications.

Mallin was not an expert on the value of computer equipment,

and did not testify as such at the trial of these cases. In

general, Mallin used and relied upon third party appraisals which

indicated that computer equipment would have no residual value

after 96 months. He did not make any specific valuations of the

underlying equipment represented in any deals he negotiated,

promoted, and brokered. Mallin's commission for brokering an

equipment leasing transaction principally depended on the amount

of cash (including short-term notes) that was involved in the

transaction. The selling price in a sale/leaseback transaction

was set by Mallin as a broker, and generally included the sale

price of the equipment, plus 3 percent, which represented

commissions earned by him on the transaction. With respect to

the computer equipment leasing deals Mallin brokered on behalf of

IRA, inflation played no factor in the economic analysis as to

whether or not a profit could be made.
 - 469 -

Mallin was a director of Chicago Holdings, Inc., at the time

of trial.

B. Richard Uhl, Funding Systems Corp., and Funding Systems
Asset Management Corp.

Richard Uhl (Uhl) was an officer of Funding Systems

Corp.(FSC), which was the parent company of a subsidiary, Funding

Systems Asset Management Corp. (FSAM) and was involved in the

equipment leasing business during the years at issue.

Uhl did not negotiate the computer leasing transactions

involving the IRA deals on behalf of FSC/FSAM.

During 1981, FSC was involved in an involuntary bankruptcy

of its subsidiary, FSAM. Leasing Services, Inc. (O.P.M.), an

entity engaged in the business of brokering computer leasing

deals, also filed a petition in bankruptcy about the same time

FSAM filed its petition.

Uhl was the debtor-in-possession of FSAM, in which capacity

he conducted the operations of FSC. While Uhl was reviewing

leasing transactions as a debtor-in-possession, he discovered

that some of the transactions had documents missing.

After FSAM emerged from bankruptcy in 1985, it split off

from its parent, FSC. FSAM changed its name to Chicago Holdings,

Inc. The directors of Chicago Holdings, Inc. included Mallin and

Weisgal. Uhl was the president. One of the shareholders of

Chicago Holdings, Inc., was a new partnership called FSAM

Partnership.
 - 470 -

C. FSAM Partnership

FSAM Partnership (hereafter FSAM) was organized December 30,

1985. Weisgal, BWK, Inc., and BRT/K Associates were partners.

The Bea Ritch Trusts were partners in BRT/K Associates.

II. Equipment Leasing

A. Equipment Leasing Generally

An investor in computer leasing equipment generally looks to

the residual value of the equipment at the end of the lease for

his profit. Because of the importance of residual value, an

investor in a computer leasing transaction would normally use a

qualified appraiser to ascertain the value of equipment involved

in a leasing activity.

B. General Facts Relative to Lack of Economic Substance, Profit
Motive and Residual Value

To the extent there was economic substance to the IRA sale

and leaseback transactions, it would principally depend on the

residual value of the equipment at the end of the lease period

between the investor and the leasing company. For the equipment

leasing transactions, the equipment owner could benefit if he

retained valuable rights to equipment after the end user's lease

and the leasing company's leasehold rights were extinguished.

The residual value, if any, of the equipment after the 96 or 108-

month lease period was the largest element of what an owner could

look for in terms of economic profit. With respect to each of

the IRA leasing transactions, IRA would make a profit on the
 - 471 -

transaction if the value of its rights to the equipment at the

end of the leaseback or leasehold right of the leasing company

(96 or 108 months) had a value in excess of IRA's financial

investment, e.g., cash, short-term notes and long-term notes.

No individuals other than Mallin provided any substantive

information regarding the equipment leasing transactions entered

into by IRA throughout the years 1976 through 1986. Mallin

determined that IRA, as an investor, could make a profit on the

leasing transactions if the residual value of the equipment, on a

date 96 or 108 months after the purchase thereof, was in excess

of the cash originally invested by IRA.

Kanter had only general discussions with Mallin as to

whether to go into a particular deal. He did not discuss in

detail the economics of the equipment leasing transactions before

the transactions were consummated. He did not get involved in

detailed discussions regarding the residual value or economic

prospects of the equipment leasing transactions of IRA and

Cedilla Invest. Kanter never determined whether any computer

leasing transactions of IRA resulted in or could result in a

profit.

IRA did not obtain appraisals as to the values of equipment

to be purchased for any of the equipment leasing deals at issue.

There were no tax spreadsheets, forecasts, projections,

accounting letters, or appraisals presented by IRA to support its
 - 472 -

claim that the transactions had economic substance and were not

shams for Federal tax purposes.

No evidence was introduced by IRA to corroborate the

financial substance of the equipment leasing transactions, such

as a record of rental payments received by IRA, payments made by

IRA on the long-term notes, payments received by IRA on

succeeding leases, and final disposition of the equipment.

In none of the equipment leasing deals entered into by IRA

did the cash-flow enable it to make a profit, absent residual

value in the equipment at the time the original leases expired.

For each of the equipment leasing deals which are at issue, there

was no residual value for the equipment at the end of each

leaseback arrangement.

C. General Facts Relating to Invalid Indebtedness and Financing
Circularity

The equipment involved in the sale and leaseback

transactions was subject at the time of such transactions to

liens held by various lending institutions which had financed the

purchase of the equipment by the relevant entity and was subject

to the lease of such equipment to various end users. The

transactions generally took the form of a sale of equipment by

the leasing company to IRA, or to an intermediary company,

subject to the preexisting liens and leases, after which the

investor or IRA then leased the equipment back to the seller, the

leasing company, for a period of 96 or 108 months.
 - 473 -

The computer leasing transactions were generally structured

with the use of an intermediary company between FSC, the leasing

company, and IRA, the investor/owner/purchaser. The intermediary

company would purportedly buy the equipment from FSC and sell it

to IRA, and IRA would then lease it back to FSC. O.P.M., Horizon

Leasing Corp. (Horizon), Pluto Leasing Corp. (Pluto), and Knight

were corporations purportedly engaged in the buying, selling, and

leasing of computer equipment, both new and used, and served as

intermediaries in some of the subject transactions.

The provisions of the Agreement of Lease between the leasing

entity and any intermediary generally coincide with the

provisions of the Agreement of Lease between IRA and the leasing

company, or IRA and an intermediary, except for minor variations

in the amounts of rent specified in the schedule thereto. With

respect to the equipment leasing transactions entered into by

FSC/FSAM and IRA, the payments made by the leasing company (FSC)

to the owner/purchaser, IRA, and the payments from the

owner/purchaser, e.g., IRA to the leasing company (FSC), coincide

or may be only slightly different for the 96- or 108-month

duration of the lease obligation between the owner and the

lessee.

The long-term notes in each of the leasing transactions

contained provisions with respect to the manner and amounts of

interest prepayments and amounts of the monthly installments
 - 474 -

which were identical to those contained in IRA's long-term note

to the leasing entity in each instance. IRA did not, generally,

assume the leasing companies' obligations under long-term notes

signed by the leasing companies to lending institutions. The

long-term promissory notes (also known as nonrecourse or limited

recourse notes) executed by IRA as the purported owner/investor

of the equipment in the transactions contained deferral

provisions triggered by the other party's defaults.

The Agreements of Lease, e.g., the leaseback by the

owner/purchaser to the leasing company, contained no provisions

that permitted the leasing company to terminate or defer the

payment of rent due to the owner/purchaser, if the leasing

company did not receive payments on the long-term notes of the

owner/purchaser. In each instance the leasing company retained

the right to receive all rentals from the end user lessees,

subject to any assignment of such rentals to the lending

institutions that had financed the purchase of the equipment and

subject to the Agreements of Lease with any intermediary. The

terms of the end user leases were always shorter than the 96- or

108-month term of the Agreements of Lease.

The lending institutions that financed the purchase of the

equipment looked solely to the rent from the end user lessees for

the repayment of their loans. These loans were to be paid off in

full at the end of the end user leases. There is no evidence
 - 475 -

that the long-term promissory notes executed by IRA in favor of

the leasing companies were fully satisfied. The failure of IRA

to make a payment due on any of its long-term notes used for the

purported purchases of the equipment did not permit the

respective lessees to stop paying rent for the equipment being

leased.

IRA, as owner/investor, could not transfer the equipment

without the prior consent of O.P.M., the leasing company.

Additionally, IRA could not take any action which would result in

the imposition of a lien on the equipment without first securing

the consent of the senior lienholder.

The sale and leaseback transactions entered into by IRA were

simultaneous, prearranged, and interrelated. IRA's required out-

of-pocket cash investment in its purchase and leaseback

transactions was more than the rents to be received from the

lessees. IRA did not have a bona fide expectation that the

equipment, in which it purportedly acquired an interest, would

have any significant residual value on the relevant deferral

date.

The transactions between IRA, O.P.M., and FSC, including the

intermediaries and IRA, were simultaneous and interrelated. The

intermediaries served no valid business purpose in IRA's

transactions with FSC and O.P.M. Horizon, Pluto, Knight, and any

other intermediary were inserted into the transactions for the
 - 476 -

sole purpose of enabling IRA to claim tax deductions. IRA made

use of intermediary companies in an attempt to avoid the at-risk

rules of section 465.

D. Miscellaneous Additional Facts Generally Applicable to the
Transactions

Neither IRA nor its advisers attempted to obtain an opinion

of the fair market value, the residual value, or the useful life

of the equipment from a party unrelated to the proposed

transactions.

Due to the large number of equity participation transactions

previously arranged by Mallin for O.P.M., the transactional

documents were essentially reduced to form documents whose terms

were the subject of little or no negotiation. All of the

transactions at issue fit the same pattern.

There were no third-party records which referred to IRA as

the owner or purchaser of the equipment. By the beginning of the

taxable year ended December 31, 1987, IRA no longer possessed the

right, title, and interest to the equipment for which it claimed

deductions and credits for computer leasing transactions for the

years 1977 through 1986.

III. The Specific Leasing Transactions

A. Cedilla Invest.-1976 Domestic (O.P.M. Transaction)

Cedilla Invest. purportedly purchased computer leasing

equipment from O.P.M. and leased the equipment back to O.P.M. in

a "bill of sale" dated October 14, 1976, and a Purchase Agreement
 - 477 -

dated December 1976 by and between Cedilla Invest. and O.P.M.

O.P.M. had purchased the subject equipment on October 14, 1976,

from Pioneer Computer Corp. for $600,000.

The purchase price stated in the Purchase Agreement between

O.P.M. and Cedilla Invest. for the computer equipment was $1

million of which $40,000 was paid at closing in cash along with a

$970,000 nonrecourse installment promissory note in favor of

O.P.M. Of the $40,000 cash paid, it appears that $10,000

represented prepaid interest. In addition, another promissory

note in the amount of $86,000 was issued, apparently also

relating to interest.

The nonrecourse installment promissory note contained

provisions for deferral and setoff of payments due O.P.M. from

Cedilla Invest. to the extent any amount of rent due Cedilla

Invest. was not paid by O.P.M. The principal sum deferred was

payable on January 1, 1986, only to the extent that O.P.M. had

paid past sums due.

The commissions paid by Cedilla Invest. totaled $55,000.

They were made payable to O.P.M. Leasing Services, Inc., and

Mallin.

With respect to the purported purchase of the equipment by

Cedilla Invest., O.P.M. entered into a collateral assignment of

leases. Mallin signed some of the documents in the Cedilla

Invest./O.P.M. leasing transactions on behalf of Cedilla Invest.
 - 478 -

as a director. Cedilla Invest. and O.P.M. executed a

substitution agreement dated January 23, 1978, which permitted

O.P.M. to substitute and exchange certain equipment for the

original leased equipment.

B. Cedilla Invest.-1977 Domestic Transaction Master Lease
Transaction)

Cedilla Invest. entered into a purported master purchase

agreement with FSC on November 27, 1977, wherein Cedilla Invest.

purchased certain computer equipment. Some of the equipment was

acquired in 1978. Cedilla Invest. then leased the equipment back

to FSC for a term of 108 months for each piece of equipment.

Included in this master lease agreement was a master remarketing

agreement.

During the term of the lease, the lessee was responsible for

maintenance of the equipment and the risk of loss from damage

thereto. The lessee had the right to sublet the equipment.

With respect to the purchase of each item of equipment under

the master agreement, Cedilla Invest. executed a limited recourse

promissory note. The limited recourse promissory note included a

deferral provision which permitted, in the event the lease was

terminated prior to the expiration thereof on account of default,

deferral of payment of the balance due on the note and any

accrued interest until December 31, 1991. The limited recourse

promissory note also included a provision authorizing Cedilla

Invest. to defer payment on its obligation under the note if the
 - 479 -

lessee failed to pay the rent due to Cedilla Invest. for a

particular piece of equipment. Under the limited recourse

promissory note, the payee agreed to look solely to the

collateral for the payment of any of the obligations of the payor

under the note. There was no right of the payee to pursue the

payor independently of the collateral. The note further provided

that the secured interest of the payee was subject to the lien

interests of senior lienholders and end users.

Checks issued by Cedilla Invest. to pay FSC provide no

evidence that FSC ever negotiated the checks.

C. Cedilla Invest.-1979 Foreign Transaction (British Aerospace
Transaction)

On October 31, 1979, a sale and purchase agreement was

effected between Atlantic Computer Leasing, Ltd. (Atlantic),

European Leasing, Ltd. (European), Carena Computers B.V.

(Carena), and Funding Systems International Corp. (Funding

International). Under this agreement, Funding International, as

purchaser, executed and delivered to Carena a nonnegotiable,

nonrecourse promissory note dated October 31, 1979, in the amount

of $2,820,501.

The computer equipment, referred to as the British Aerospace

transaction, consisted of IBM computers located in England and

was subject to various leases. The equipment was identified as

follows: (1) British Aerospace 5-year lease for an I.B.M. model

3032 and other equipment; (2) Unichem, Ltd. 6-year lease for an
 - 480 -

I.B.M. model 3031 and other equipment; and (3) Cheshire County

Council 6½-year lease for an I.B.M. model 3031, and other

equipment. The entities named were the end users of the computer

equipment which had been purchased on or about October 10, 1979.

Under the agreements between Atlantic, European, Carena, and

Funding International, Atlantic transferred to Carena, and Carena

to Funding International, the interests of Atlantic in the

computers used by the end users. With respect to this

transaction, Funding International executed, in favor of Carena,

a nonnegotiable, nonrecourse promissory note in the amount of

$1,403,601 dated October 31, 1979.

On October 31, 1979, an agreement of lease was executed by

and between Funding International and Carena, leasing the

property back to Carena.

The sale and purchase agreement between Atlantic, European,

Carena, and Funding International allowed European to sell,

transfer, and assign to Carena all of Atlantic's interest in the

equipment. Atlantic would own the equipment subject to the lease

only upon repayment of the repurchase price specified in the

residual agreement. Atlantic, therefore, did not have legal

title to the property as of October 31, 1979, but agreed to

obtain legal title after the original end user lease expired.

Under the sale and purchase agreements, Atlantic and

European agreed to deliver to Carena the instruments Carena
 - 481 -

needed to assure ownership of and legal title to the equipment

free of any liens, except the lease, after the initial lease term

expired. This was pursuant to the residual agreements.

On October 31, 1979, Funding International and Carena

entered into a purchase agreement regarding other computer

equipment involved as part of the British Aerospace Transaction.

Under the residual agreement between Atlantic and Willowbrook

International, a leasing company, made with respect to this

transaction, the resale of the equipment to Atlantic had a

repurchase price of one and one-half of its original cost and

would occur 6½ years from the date of the original lease. The

stated value of the equipment was $1,506,099. The equipment was

to be used by the Cheshire County Council.

With respect to this equipment, Funding International

executed a nonnegotiable, nonrecourse promissory note to Carena

in the amount of $1,462,793 dated October 31, 1979. This

promissory note contained deferral and offset provisions allowing

the purchaser/owner of the equipment to defer any payments on the

notes, if the leases were terminated prior to the expiration or

there was default thereof, and then to offset the deferred

amounts against any payment due under the notes.

On October 31, 1979, Funding International and Carena

entered into an agreement of lease with respect to the Chesire

equipment, leasing the property back to Carena.
 - 482 -

On October 31, 1979, Atlantic, European, Carena, and Funding

International executed a sale and purchase agreement regarding

other equipment which was part of the British Aerospace

transaction. The stated value of the equipment was $3,042,338.

Under this agreement, Atlantic and European transferred

Atlantic's interest in the equipment to Carena, subject to

Atlantic’s acquiring title to the equipment under the residual

agreement.

Under the residual agreement, Atlantic agreed that upon the

expiration of the initial term of the lease, it would make

payment of the balance of the purchase price and agreed to

deliver to Carena the instruments necessary to ensure ownership

of, and legal title to, the equipment. The parties agreed that

Atlantic would, upon the expiration of the initial term of the

lease, undertake the necessary steps to have the equipment

purchased at a price equal to 2 percent of its original cost.

On October 31, 1979, Carena and Funding International

executed a purchase agreement relating to this equipment.

Funding International, as purchaser/owner, issued a nonrecourse

installment promissory note to Carena, dated October 31, 1979, in

the principal sum of $1,462,793 and interest payments for the

balance of $22,132.28 and $37,392.28. The parties entered into

an agreement of lease dated October 31, 1979, leasing the

equipment back to Carena.
 - 483 -

Pluto, a New York corporation affiliated with Mallin,

executed a purchase agreement dated December 30, 1979, by and

between Pluto and Funding International pursuant to which Funding

International delivered a bill of sale dated December 30, 1979,

in favor of Pluto.

Under the purchase agreement, Pluto, the purchaser, obtained

Funding's interest in and to all of the equipment, which was

subject to prior leases made between Carena and others such as

Delco Leasing, Ltd., Woolworth Leasing, Ltd., Willowbrook

International, Ltd., various leasing companies, or Atlantic

Computer Leasing, Ltd. Pursuant to this purchase, the purported

price between the parties was $6,108,051, payable by delivery of

a certified check in the amount of $180,000 and a recourse

installment promissory note in the sum of $5,928,051. IRA

claimed the equipment was worth $5,108,573 on its income tax

returns. The computer equipment involved was located in England

and consisted of the British Aerospace, Unichem, and Cheshire

properties described above. The agreement was subject to the

existing underlying leases and the residual agreements made with

the end users.

With respect to this transaction, Pluto, as the purchaser,

issued a check to Funding International in the amount of

$185,000. There is no indication this check was negotiated.
 - 484 -

On December 30, 1979, a purported purchase agreement was

executed between Cedilla Invest. and Pluto pursuant to which

Pluto sold to Cedilla Invest. the IBM equipment as to which

British Aerospace, Unichem, and Cheshire County Council were end

users. The selling price was $6,118,051, made payable by a check

for $190,000 and a limited recourse promissory note for

$5,928,051 executed by Cedilla Invest.

In connection with the Cedilla Invest./Pluto agreement,

Cedilla Invest. additionally executed a promissory note in favor

of Pluto in the amount of $260,000, dated December 30, 1979, and

another promissory note dated December 30, 1979, in the amount of

$95,625.

Under the security provision, the lien of Pluto was

subordinate to the interests of underlying lessees, the rights of

Atlantic under the residual agreement, and the proceeds from the

rent of the equipment in excess of $475 per period received by

Cedilla Invest. from Funding International.

The limited recourse promissory note contained a provision

for deferral, which permitted the payor to defer any sums,

principal and interest, due under the note, if any amount of rent

or sum due under the lease was not received by the payor as the

sum became due. The deferral allowed the payor, Cedilla Invest.,

to defer payment to December 31, 1994, without paying accrued

interest on the amount so deferred. In addition, under the
 - 485 -

limited recourse obligations, the payor was personally liable

only for the interest and principal under the note due during the

times, and only during the times, and in the amounts and only to

the extent of such amounts, as set forth in schedule A thereto,

without giving effect to the deferred payments, if any.

Under this provision, recourse obligations were determined

as of the date and occurrence of default. Under schedule A, the

maximum amount of recourse obligation as of January 1, 1988, was

zero. The balance of the obligation was nonrecourse, and the

payee looked only to the collateral for payment.

The purchase agreement between Pluto and Cedilla Invest. was

made pursuant to a certificate of resolutions of the

corporations' board of directors attested to by Meyers.

On December 30, 1979, Funding International purportedly

agreed to a collateral assignment of the lease with respect to

the computer leasing equipment to Cedilla Invest., subject to the

leases of Funding International. The result of the assignment

was that Cedilla Invest. received the payments under the existing

leases from the end users. In December 1979, Cedilla Invest. and

Funding International entered into an agreement of lease and a

remarketing agreement regarding the computer leasing equipment.

The term of the lease between Cedilla Invest. and Funding

International was through December 31, 1988. Under the lease,

the lessee could replace equipment subject thereto.
 - 486 -

Under the remarketing agreement, Funding International

agreed to act as agent for Cedilla Invest. in remarketing the

equipment, after the expiration of the original underlying

leases.

As of January 1986, the equipment was not listed in the

computer price guide, "The Blue Book of Used IBM Computer

Prices". Its residual value was zero.

Kanter received information regarding the Funding

International/Cedilla Invest. transaction in December of 1979, in

a letter from the attorneys for Funding International. The

information included with the letter consisted of title documents

to the property, none of which documents was produced or provided

for incorporation in the record in this litigation.

On January 17, 1980, a letter was sent from Attorney Alan

Axelrod regarding the delivery of promissory notes of Cedilla

Invest. for itself and its nominee, Kanter.

With respect to the British Aerospace transaction, the total

cash investment of Cedilla Invest., including the downpayment and

all interest to be paid on its notes was to be $11,982,686; the

rent to be received from Funding International was a total of

$11,483,360.38. There was a net loss of $499,325.62 on the

transaction.
 - 487 -

D. IRA-1980 Domestic Transaction ("Mini Computer Transaction")

On December 31, 1980, a bill of sale was executed by the

FSAM partnership in which Kanter was involved, to F/S Computer

Corp. (FS) for certain equipment. On December 31, 1980, FS sold

the equipment to Horizon for $870,025, payable with a cashier's

check for $5,700 and a full recourse promissory note by Horizon

in the amount of $864,325. The recourse promissory note included

a deferral provision allowing the payor to defer payment of

principal and interest on the note, if any amount of principal or

interest becoming due to Horizon under the limited recourse

installment promissory note of even date issued by IRA to Horizon

was not paid. Under this provision, deferral could continue

until December 31, 1995. The amount deferred would not accrue

interest. Horizon then sold the equipment to IRA, and IRA then

leased the equipment to FS. As part of the purported sale of the

equipment to IRA, IRA executed in favor of Horizon a limited

recourse promissory note. The sale to IRA by Horizon was on

December 31, 1980, and was for $872,025. The sale was subject to

all underlying leases.

In a letter of direction from IRA, FS agreed to deduct from

the rent FS owed to IRA, under the leasing agreement, an amount

equal to the monthly payments owed by IRA to Horizon under the

note from IRA. The amounts for these payments were equal.

Accordingly, the payments on the notes were bookkeeping entries.
 - 488 -

With respect to the purported purchase agreement, IRA

executed a promissory note in the amount of $24,000 to Horizon,

another promissory note to Horizon dated December 31, 1980, in

the amount of $25,000; and a limited recourse promissory note-

security agreement dated December 31, 1980, in the amount of

$864,325.

Under the security provision of the note, IRA granted

Horizon a security interest in the equipment subject to the

interests of prior lienholders and the underlying lessee.

Under the limited recourse promissory note, the payor, IRA,

had the right to defer payment of principal and interest to

Horizon as it became due, if and to the extent any amounts of

rent or other sum due to IRA under the lease with FS was not paid

when due. Under this provision, the payments could be deferred

until December 31, 1995. The deferred amount did not accrue

interest.

The recourse obligation under the limited recourse

promissory note between IRA and Horizon provided that Horizon had

recourse against IRA with respect to failure to make proper

payments on the note as of January 1, 1989, in the amount of zero

dollars. The recourse obligations of IRA under the note were

determined only in accordance with the schedule attached thereto

during the times and in the amounts set forth in that schedule.
 - 489 -

The recourse provisions were determined without giving effect to

the deferral provisions.

Under the limited recourse promissory note and security

agreement, the leased equipment could be replaced with other

equipment not initially secured by the note. Under the limited

recourse provision of the long-term note, the seller looked

solely to the collateral for payment by the buyer, other than the

buyer's recourse obligation described earlier.

On December 31, 1980, IRA provided a letter to FS regarding

the offsetting of payments made under the promissory notes and

the leases. IRA directed FS to deduct from the monthly rent

payments owed to IRA an amount equal to the note payments owed by

IRA to Horizon and that FS pay the deducted amount directly to

Horizon for the account of IRA.

With respect to the IRA/Horizon purported purchase

agreement, FS delivered the collateral assignment of leases dated

December 31, 1980, to IRA. An agreement of lease between IRA and

FS was executed on December 31, 1980. In addition, a remarketing

agreement by and between IRA and FS was consummated.

With respect to the IRA/Horizon leasing transaction, the

total cash investment of IRA was to be $2,044,264. The total

rent due FSC was $1,978,323.79, resulting in a loss of

$65,940.21. As of January 1986, the residual value of the

equipment subject to the sale and leaseback was zero.
 - 490 -

E. IRA-1980 Foreign/Domestic Transaction ("Alfred Teves
Transaction")

A purported purchase agreement dated December 31, 1980, by

and between Funding International and Funding Systems

International GmBH (Funding GmBH) was consummated, pursuant to

which Funding GmBH sold certain equipment to Funding

International for $931,321, paid by a check in the amount of

$18,721, and a nonrecourse note in the amount of $912,600.

The schedule attached to the bill of sale with respect to

the property contained duplicate schedules of certain equipment

located in Belgium at two locations: One at Alfred-Teves

Strasse, 3170 Gifhorn, and one at Muller Strasse, 4-14, 5275

Bergneustadt 1. All of this equipment is referred to as the

Alfred Teves transaction.

The $912,600 note executed by Funding International included

a provision for deferral of payment by the payor, in the event

amounts due for rent with respect to the lease between payor and

payee were not made. The amount deferred would become payable on

December 31, 1995, and would not accrue interest. The note was

nonrecourse in that the payee looked solely to the collateral for

payment of the obligation.

Consistent with the agreement of purchase, Funding

International and Funding GmBH entered into an agreement wherein

the equipment was leased back to Funding GmBH.
 - 491 -

On December 31, 1980, a purported purchase agreement between

Horizon and Funding International was executed wherein the Alfred

Teves computer equipment was sold by Funding International to

Horizon. The sale/purchase agreement between Funding

International and Horizon included the Alfred Teves transaction

equipment, along with certain other equipment located in Belgium.

The price for this sale was $4,276,701, payable by a cashier's

check for $20,000 and $4,256,701 by a full-recourse installment

promissory note in favor of the seller, Funding International.

IRA and Horizon signed a purported purchase agreement dated

December 31, 1980, in which Horizon sold the property to IRA for

$4,281,701, payable by a certified check for $25,000 and a

limited recourse promissory note issued by IRA in favor of

Horizon in the amount of $4,256,701. The amount owed to Funding

International from Horizon was equal to the amount of the

payments to Horizon from IRA under the purported purchase and

sale agreement. The limited recourse promissory note provided

that IRA could defer payment of principal and interest as it

became due if, and to the extent, any amount of rent or any other

sum due to IRA under the lease between Funding International and

Funding GmBH was not received timely by the payor. The sum could

be deferred until December 31, 1995. The deferred sum did not

accrue interest.
 - 492 -

IRA also executed in favor of Horizon a promissory note

dated December 31, 1980, in the amount of $120,000, and another

promissory note dated December 31, 1980, in favor of Horizon in

the amount of $111,900.57

Pursuant to the transaction for the sale and leaseback of

the computer equipment, Funding International executed a

collateral assignment of leases to IRA.

F. Cedilla Invest. "Lexet Transactions"

On December 22, 1986, Cedilla Invest. purportedly purchased

certain IBM-manufactured computer equipment from Lexet Leasing

Corp. (Lexet) for a stated purchase price of $1,260,016. This

equipment had been previously or simultaneously acquired by Lexet

from Beta Gamma Leasing Corp., which entity had previously or

simultaneously acquired the equipment from O.P.M. The equipment

was subject to an end user lease with General Motors Corp.,

Cadillac Division, Detroit, Michigan.

The stated purchase price of $1,260,016 was, according to

the terms of the purchase agreement, payable as follows: $6,300

in cash on the date of the agreement; a short-term promissory

note payable on May 15, 1987, in the amount of $69,300; and a

long-term "limited recourse" promissory note in the amount of

$1,184,416. Under the terms of the "limited recourse promissory

note", Cedilla Invest. was only personally liable during the

57
The record contains no explanation for these notes.
 - 493 -

times and to the extent of the amounts referenced in schedule B

annexed thereto. Schedule B specifically provided that the

payor's (Cedilla Invest.'s) "maximum aggregate amount" of

personal liability was zero. Further, and also under the terms

of the note, Cedilla Invest.'s only obligation with respect to

payment of the amounts due thereunder was expressly in the nature

of "nonrecourse obligation", and the payee "shall look solely and

only to the Collateral for the payment and performance" of

Cedilla Invest.'s obligations under the note.

On December 22, 1986, Cedilla Invest. also purportedly

purchased certain IBM-manufactured computer equipment from Lexet

for a stated purchase price of $1,452,127. This equipment had

been previously or simultaneously acquired by Lexet from Proz

Leasing Associates, Inc., which entity had previously acquired

the equipment from JAL Group, Inc. (in 1980), and previously or

simultaneously from Sha-Li Leasing Corp. The equipment was

transferred subject to an end user lease with Information

Services Group, a division of Mars, Inc., Randolph, New Jersey.

The stated purchase price of $1,452,127 was, according to

the terms of the purchase agreement, payable: $7,200 cash at the

time of the execution of the agreement; a short-term promissory

note payable on May 15, 1987 in the amount of $79,200; and a

long-term "limited recourse" promissory note in the amount of

$1,365,727. Under the terms of the "limited recourse promissory
 - 494 -

note", Cedilla Invest. was only personally liable during the

times and to the extent of the amounts referenced in schedule B

annexed thereto. Schedule B specifically provided that the

payor's (Cedilla Invest.'s) "maximum aggregate amount" of

personal liability was zero. Further, and also under the terms

of the note, Cedilla Invest.'s only obligation with respect to

payment of the amounts due thereunder was expressly in the nature

of a "nonrecourse obligation", and the payee "shall look solely

and only to the Collateral for the payment and performance" of

Cedilla Invest.'s obligations under the note.

Other than the purchase agreements, bills of sale, and

promissory notes, IRA did not produce any other documents in

connection with these equipment leasing transactions, such as

equipment appraisals, economic forecasts, related correspondence,

legal opinions, rent payment schedules, checks (negotiated or

otherwise) evidencing payments of purchase price or rentals, or

records establishing the existence or actual location of the

equipment at any time during the subject leases.

The intermediary entities involved in these transactions

(Beta Gamma Leasing Corp. and Proz Leasing Corp.) served no

economic or business purpose, and were only part of the

transactions for Federal tax purposes.
 - 495 -

G. Cedilla Invest. "Ben Energy Transactions"

On December 22, 1986, Cedilla Invest. purportedly purchased

certain IBM-manufactured computer equipment and peripherals from

Ben Energy Systems, Inc. (Ben Energy), for a stated purchase

price of $1,325,068. This equipment had been previously or

simultaneously acquired by Ben Energy from Horizon Leasing Corp.,

which entity had previously acquired the equipment from New

England Rare Coin Galleries, Inc. (in 1980), and previously or

simultaneously from Funding Systems International Corp. The

equipment/peripherals were all transferred subject to several end

user leases with various entities located in England.

The stated purchase price of $1,325,068 was, according to

the terms of the purchase agreement, payable as follows: $6,600

cash at the time of the execution of the agreement; a short-term

promissory note payable on May 15, 1987, in the amount of

$72,600; and a long-term, "limited recourse" promissory note in

the amount of $1,245,868.

Under the terms of the "limited recourse promissory note",

Cedilla Invest. was only personally liable during the times and

to the extent of the amounts referenced in schedule B annexed

thereto. Schedule B specifically provided that the payor's

(Cedilla Invest.'s) "maximum aggregate amount" of personal

liability was zero. Further, and also under the terms of the

long-term note, Cedilla Invest.'s only obligation with respect to
 - 496 -

payment of the amounts due thereunder was expressly in the nature

of a "nonrecourse obligation", and the payee "shall look solely

and only to the Collateral for the payment and performance" of

Cedilla Invest.'s obligations under the note.

On December 22, 1986, Cedilla Invest. purportedly purchased

certain IBM-manufactured computer equipment from Ben Energy for a

stated purchase price of $2,418,244. The transactional history

of this equipment (aside from the end user lease on the property)

is that on May 31, 1980, Continental Information Systems GmbH

(Continental) sold the equipment to Neptune Leasing Corp.

(Neptune). On the same date, Neptune leased the equipment back

to Continental. Then, on May 31, 1980, Continental assigned its

lease interest back to Neptune. On June 19, 1980, Neptune sold

the equipment and all its interests therein to New England Rare

Coin Galleries, Inc. (NERC). On June 30, 1982, NERC sold the

equipment and all its interests therein to Ben Energy. All of

these transfers were made subject to the end user lease in favor

of an entity located at the time in what was then West Germany.

The stated purchase price of $2,418,244 was, according to

the terms of the purchase agreement, to be paid by Cedilla

Invest. to Ben Energy as follows: $12,000 cash at the time of

the execution of the agreement; a short-term promissory note

payable on May 15, 1987 in the amount of $132,000; and a long-
 - 497 -

term, "limited recourse" promissory note in the amount of

$2,274,244.

Under the terms of the "limited recourse promissory note",

Cedilla Invest. was personally liable only during the times and

to the extent of the amounts referenced in schedule B annexed

thereto. Schedule B specifically provided that the payor's

(Cedilla Invest.'s) "maximum aggregate amount" of personal

liability was zero. Further, and also under the terms of the

note, Cedilla Invest.'s only obligation with respect to payment

of the amounts due thereunder was expressly in the nature of a

"nonrecourse obligation", and the payee "shall look solely and

only to the Collateral for the payment and performance" of

Cedilla Invest.'s obligations under the note.

Other than the purchase agreements, bills of sale, and

promissory notes, IRA did not produce any other documents in

connection with these equipment leasing transactions, such as

equipment appraisals, economic forecasts, related correspondence,

legal opinions, rent payment schedules, checks (negotiated or

otherwise) evidencing payments of purchase price or rentals, or

records establishing the existence or actual location of the

equipment at any time during the subject leases.

The intermediary entities inserted in these transactions

(Horizon Leasing Corp., Neptune Leasing Corp.) served no economic
 - 498 -

or business purpose and were only part of the transactions for

Federal tax purposes.

H. Cedilla Invest. "Dard Systems Transactions"

On December 22, 1986, Cedilla Invest. purportedly purchased

certain IBM-manufactured computer equipment from Dard Systems,

Inc. (Dard), for $3,615,100. Prior thereto, on June 29, 1981,

Funding Systems International had sold this equipment to

Equitable Leasing Co., and on the same date, Equitable Leasing

Co. had leased the equipment back to Funding Systems

International. Equitable Leasing Co., on September 30, 1981,

sold the equipment to Dard, and thereafter Dard sold the

equipment to Cedilla Invest. on December 22, 1986, subject to

several end user leases with various entities in England as well

as the lease encumbering the equipment in favor of Funding

Systems International.

The stated purchase price of $3,615,100 was, according to

the terms of the purchase agreement, to be paid by Cedilla

Invest. to Dard as follows: $18,000 cash payable at the time of

the execution of the agreement; a short-term promissory note

payable on May 15, 1987, in the amount of $198,000; and a long-

term, "limited recourse" promissory note in the amount of

$3,399,100.

Under the terms of the "limited recourse promissory note",

Cedilla Invest. was personally liable only during the times and
 - 499 -

to the extent of the amounts referenced in schedule B annexed

thereto. Schedule B specifically provided that the payor's

(Cedilla Invest.'s) "maximum aggregate amount" of personal

liability was zero. Further, and also under the terms of the

note, Cedilla Invest.'s only obligation with respect to payment

of the amounts due thereunder was expressly in the nature of a

"nonrecourse obligation", and the payee "shall look solely and

only to the Collateral for the payment and performance" of

Cedilla Invest.'s obligations under the note.

On December 22, 1986, Cedilla Invest. also purportedly

purchased certain Wang-manufactured computer equipment and

peripherals from Dard for a stated purchase price of $746,608.

This equipment had the same transactional history as the property

described above in the $3,615,100 transaction except that F/S

Computer Corp. was involved instead of Funding Systems

International as the intermediary lessee. The equipment in this

transaction was subject to several end user leases with various

entities located in North America.

The stated purchase price of $746,608 was, according to the

terms of the purchase agreement, payable as follows: $3,700 cash

at the time of the execution of the agreement; a short-term

promissory note payable on May 15, 1987, in the amount of

$40,700; and a long-term "limited recourse" promissory note in

the amount of $702,208.
 - 500 -

Under the terms of the "limited recourse promissory note",

Cedilla Invest. was personally liable only during the times and

to the extent of the amounts referenced in schedule B annexed

thereto. Schedule B specifically provided that the payor's

(Cedilla Invest.'s) "maximum aggregate amount" of personal

liability was zero. Further, and also under the terms of the

note, Cedilla Invest.'s only obligation with respect to payment

of the amounts due thereunder was expressly in the nature of a

"nonrecourse obligation", and the payee "shall look solely and

only to the Collateral for the payment and performance" of

Cedilla Invest.'s obligations under the note.

On December 22, 1986, Cedilla Invest. also purportedly

purchased certain computer equipment and peripherals from Dard

for a stated purchase price of $640,710. This equipment also had

the same transactional history as the equipment involved in the

$746,608 transaction. The equipment was transferred subject to

several end user leases with various entities.

The stated purchase price of $640,710 was, according to the

terms of the purchase agreement, payable as follows: $3,200 cash

payable at the time of the execution of the agreement; a short-

term promissory note payable on May 15, 1987, in the amount of

$35,200; and a long-term "limited recourse" promissory note in

the amount of $602,310.
 - 501 -

Under the terms of the "limited recourse promissory note",

Cedilla Invest. was only personally liable during the times and

to the extent of the amounts referenced in Schedule B annexed

thereto. Schedule B specifically provided that the payor's

(Cedilla Invest.'s) "maximum aggregate amount" of personal

liability was zero. Further, and also under the terms of the

note, Cedilla Invest.'s only obligation with respect to payment

of the amounts due thereunder was expressly in the nature of a

"nonrecourse obligation", and the payee "shall look solely and

only to the Collateral for the payment and performance" of

Cedilla Invest.'s obligations under the note. Other than the

purchase agreements, bills of sale, and promissory notes, IRA did

not produce any other documents in connection with these

equipment leasing transactions, such as equipment appraisals,

economic forecasts, related correspondence, legal opinions, rent

payment schedules, checks (negotiated or otherwise) evidencing

payments of purchase price or rentals, and/or records

establishing the existence or actual location of the equipment at

any time during the subject leases.

OPINION

I. Leasing Transactions Generally

To be entitled to the depreciation and interest deductions,

tax credits, and losses claimed in connection with the computer

equipment sale and leaseback transactions engaged in by IRA for
 - 502 -

the years at issue, IRA must prove that it had ownership of the

equipment in each transaction and that the long-term promissory

notes executed to finance the equipment transactions constituted

valid indebtedness. See Knetsch v. United States, 364 U.S. 361

(1960); Deegan v. Commissioner, 787 F.2d 825, 827 (2d Cir. 1986),

affg. T.C. Memo. 1985-219. The essence of a bona fide debt is an

unconditional and legally enforceable obligation for the payment

of money. See Linder v. Commissioner, 68 T.C. 792, 796 (1977).

This Court has held that the circular financing of computer

leasing transactions utilizing long-term promissory notes similar

or identical to the financing used in these transactions

constitutes invalid indebtedness. See Bussing v. Commissioner,

88 T.C. 449, supplemented by 89 T.C. 1050 (1987); HGA Cinema

Trust v. Commissioner, T.C. Memo. 1989-370 (a case involving a

Kanter-related computer leasing transaction with many of the same

individuals and entities involved herein), affd. 950 F.2d 1357

(7th Cir. 1991).

In addition to establishing that the long-term promissory

notes constituted bona fide indebtedness, IRA must prove that the

transactions had a business purpose and economic substance apart

from the claimed tax benefits. A transaction entered into solely

for the purpose of tax avoidance and which has no independent

economic substance to support it is a sham transaction and will

not be recognized for Federal income tax purposes. See Frank
 - 503 -

Lyon Co. v. United States, 435 U.S. 561 (1978); Rice's Toyota

World, Inc. v. Commissioner, 81 T.C. 184, 195 (1983), affd. on

this issue 752 F.2d 89 (4th Cir. 1985).

We have held for the Commissioner in connection with

computer sale and leaseback transactions structured similarly to

those involved in these cases relating to equipment similar to

that purportedly underlying the transactions at issue herein.

See Friendship Dairies, Inc. v. Commissioner, 90 T.C. 1054

(1988); HGA Cinema Trust v. Commissioner, supra. Present value

analysis and the existence of positive cash-flow are significant

elements in establishing economic substance. See Hilton v.

Commissioner, 74 T.C. 305, 353 n.23 (1980), affd. per curiam 671

F.2d 316 (9th Cir. 1982). The financing of transactions with

deferred indebtedness that is unlikely to be paid is a strong

indication of a lack of economic substance. See Hudson v.

Commissioner, 103 T.C. 90 (1994), affd. without published opinion

71 F.3d 877 (5th Cir. 1995).

In addition to establishing economic viability, IRA must

establish that it had sufficient benefits and burdens of

ownership with respect to the underlying equipment to be treated

as the owner for tax purposes and thus allowed the interest and

depreciation deductions and the tax credits in connection

therewith. In making its factual determination, the Court has

examined the substance of the transactions and the intention of
 - 504 -

the parties, rather than merely the form they have taken. See

Grodt & McKay Realty Inc. v. Commissioner, 77 T.C. 1221 (1981);

see also Torres v. Commissioner, 88 T.C. 702 (1987).

IRA contends that each of the leasing transactions had a

business purpose and economic substance apart from potential tax

benefits. In advancing this contention, it relies on (1)

Mallin's testimony regarding the residual value of the equipment

in these transactions and (2) Uhl's testimony regarding Funding

Systems' intent to enforce the long-term promissory notes that

IRA and/or Cedilla Invest. issued. Specifically, with respect to

the question of whether these transactions had economic

substance, it is acknowledged that the equipment's residual value

is crucial because there was insufficient excess cash-flow from

the equipment during the lease terms to enable IRA and/or Cedilla

Invest. to make a profit. IRA further asserts that the long-term

notes issued in connection with these leasing transactions were

valid indebtedness.

Respondent, on the other hand, contends that the

transactions were shams that were entered into by IRA and/or

Cedilla Invest. purely for tax benefits. Respondent, citing HGA

Trust v. Commissioner, supra, also maintains that the long-term

notes IRA and/or Cedilla Invest. issued were not valid

indebtedness because neither would likely ever be required to

make payments in view of the deferral provisions in each note.
 - 505 -

In addition, respondent argues that the testimony of Mallin and

Uhl is suspect and not credible.

We agree with respondent. At the outset we observe,

contrary to certain facts alleged by IRA, that this record

clearly establishes that IRA was engaged in the practice of

purchasing tax benefits, rather than buying and leasing computer

equipment for economic, profit-oriented reasons.

To fully appreciate IRA's tax motivation for entering into

these leasing transactions, we have considered them in the

context of the schemes and other issues raised in these

consolidated cases. There is no doubt that IRA was a vital cog

in Kanter's sophisticated financial machinations. IRA, Holding

Co., the "black box" represented by Administration Co. and

Principal Services, and the other various investment entities

created as alter egos of Kanter, constituted devices by which

Kanter received and disguised fees for his personal services,

including moneys received pursuant to the Prudential scheme.

When these matters are viewed in context, we are persuaded that

the leasing transactions were consummated for the sole purpose of

producing deductions sufficient to offset the income reported on

IRA's Federal income tax returns. Furthermore, to ensure that no

net income would have to be reported by IRA, all of the equipment

was effectively disposed of after the tax benefits were fully

utilized.
 - 506 -

In our view the equipment leasing investments constituted

nothing more than paper transactions designed solely to shelter

IRA's income. This is established primarily by IRA's failure to

produce any credible evidence that actual equipment purchases

took place, that the underlying equipment was ever in existence

or placed in service, or that there were ever any payments made

on the purported long-term promissory notes. The sham nature of

these transactions is revealed by IRA's failure to prepare or

produce a single equipment appraisal, residual or fair market

value opinion, income projection, economic forecast, or any other

type of financial analysis or similar supporting document in

connection with the transactions.

There are several reasons why respondent prevails on this

issue. First, IRA's transactions with the leasing companies, and

any intermediaries, lacked economic substance and business

purpose, and therefore must be disregarded for Federal income tax

purposes as sham transactions.

The analysis of IRA's transactions is essentially a two-

pronged inquiry. The first prong, the business purpose test,

addresses IRA's motives for entering into the transaction. See

Rice's Toyota World Inc. v. Commissioner, 81 T.C. at 192. The

second prong, the economic substance test, involves an objective

analysis of the transaction to determine whether or not it had

any realistic prospect of economic profit, exclusive of tax
 - 507 -

benefits. However, the presence of a business purpose does not

necessarily confirm recognition for Federal tax purposes if

objective indicia of economic substance indicating a realistic

potential for economic profit are not manifest. See Larsen v.

Commissioner, 89 T.C. 1229 (1987), affd. in part, revd. in part

909 F.2d 1360 (9th Cir. 1990). IRA's transactions will not

constitute a sham, factual or legal, as long as IRA can

demonstrate a legitimate nontax motive for entering into the

transactions and a reasonable opportunity for profit, exclusive

of tax benefits. This, of course, assumes the transactions were

something other than merely the affixation of various signatures

to forms, facts not demonstrated by IRA in view of all the

circumstances.

We think IRA has failed in its burden of proof. Considering

the economics of the transactions, we note that none of the

transactions had the requisite economic substance, unless the

transactions reasonably could be expected to return cash to IRA

in an amount in excess of that invested. In this regard, the

sale leaseback transaction could return cash to IRA from only two

sources. First, the amount of rent due to IRA each month under

its lease with the specific seller/lessee, e.g., O.P.M., could

exceed the amount of the cash paid at closing, the payments made

on the short term notes, plus the monthly payments required under

its long-term notes to the payee thereunder by an amount
 - 508 -

sufficient to provide a cash-flow in excess of IRA's investment.

However, in the subject transactions, the rent payments to be

received by IRA never equaled the payments made and due so as to

allow IRA even to recover its total investment. Second, IRA was

purportedly entitled to any proceeds from the sale or re-lease of

the equipment, at the end of its leases with each lessee, less

expenses of such sale or re-lease and less payment, generally, of

a 10-percent remarketing fee. No expert testimony was presented

by IRA regarding residual value. In fact, there was no specific

evidence (such as appraisals or projections) of the value of the

equipment presented by IRA at any time for any of the

transactions at issue, other than the general statements made by

IRA's witness Mallin regarding intent to profit.

In Friendship Dairies, Inc. v. Commissioner, 90 T.C. 1054

(1988), the Court discussed leasing transactions similar to those

involved here. O.P.M., the taxpayer, and an intermediary were

involved in the pro forma equipment transaction. Remarketing

agreements, limited recourse promissory notes, and the

circularity of payments with minimal cash-flow to the lessor were

present. Mallin promoted the deal. Like the transactions at

issue here, tax benefits were clearly the driving force of the

deal. Residual value was a critical factor in determining that

economic substance existed.
 - 509 -

The expected return of an investor in equipment leasing

transactions is rent and residual value at the end of the lease

term with the lessee, here generally 108 months. In contrast to

Friendship Dairies, Inc., there were no tax spreadsheets,

appraisals, or accounting letters presented by IRA to support a

claim of expected residual value which could produce a profit.

The Court has not been provided with any projections of residual

value or useful life, which certainly would be present in an

objective economic analysis.

As in Friendship Dairies, there is no persuasive evidence of

any motivation for the transactions, other than obtaining tax

benefits. The benefits herein (enormous interest and

depreciation deductions and credits) were primarily designed to

"shelter" the money reported as income by IRA from Kanter's

Prudential scheme.

Kanter testified he did not make a specific economic

analysis of the transactions. He relied on Mallin, his friend

and the promoter/broker of the deals, without any independent

evidence that the deals had economic substance. Mallin's

credibility is obviously tainted based on his relationship to

Kanter and his affiliated entities. He was not an independent

outsider.

As in Friendship Dairies, the witnesses presented on behalf

of IRA in this case were obviously biased, and their testimony
 - 510 -

was not credible. Mallin presented no substantive evidence in

the cases herein. He summarily stated that the transactions were

intended to be profitable. His reasoning was based on the fact

that Kanter was getting a "sweetheart deal".

Mallin did not state how favors given to Kanter would enable

IRA to profit from the deals. Since any profit would result only

if the rents, plus residual value, exceeded the amount of the

cash invested (the downpayment plus note payments), it would not

matter that Mallin permitted IRA to pay only 5 percent down,

rather than 10 percent. If there was no residual value after the

lease expired, the possibility of an economic profit was nil.

See Friendship Dairies. Mallin's testimony is, accordingly,

misleading and not supportive of a proper analysis of

profitability.

Mallin implied, without specific delineation, that IRA could

profit because he claimed the residual value would exceed the

cash invested and that the deals involved leveraged financing.

His analysis did not consider the discounted residual value of

the equipment since inflation was admittedly not taken into

account and thus the time value of money was not considered by

him. This was at a time when inflation was occurring at high

rates. A present value analysis is important to the

determination of whether a transaction has economic substance, as

discussed in Hilton v. Commissioner, 74 T.C. at 353 n.23, where
 - 511 -

this Court said little weight should be placed on the speculative

possibility that property will have substantial residual value.

All IRA produced here was unfounded speculation. No mention of a

specific piece of IBM equipment (or peripheral) is reflected in

the testimony of IRA's witnesses.

In Hilton, positive cash-flow was indicative of profit.

Otherwise, the taxpayer had no incentive to retain property

subject to substantial debt, producing no such cash-flow. It

would be prudent to abandon the property. Tax considerations

aside, if the cash-flow was negligible, as it was here, the total

projected return, if any, of IRA was too small for it to wait

until the time the leases expired. This is certain even if only

a minimal cash investment is made, and a long period of time (9

years) occurs before any property is available for profit. As in

Hilton, there was no motivation for IRA's participating in the

subject transactions, other than to obtain the tax benefits

designed to shelter the Prudential income. IRA had no business

purpose to wait 8 or 9 years to receive property at that time,

with no reasonable prospect of substantial value, e.g. an amount

in excess of its investment. This is supported by the fact that,

by 1987, IRA no longer retained much of the property purportedly

acquired as part of the sale and leaseback transactions. Its tax

shelter incentives had expired.
 - 512 -

As the Court has noted in its previous opinions in this

area, the residual value of computer equipment at any given point

in time depends in part on the rate of introduction of new,

technically advanced equipment models. See Estate of Thomas v.

Commissioner, 84 T.C. at 426. Based on all of the facts and

circumstances involved, IRA's transactions resulted in net out-

of-pocket losses. Thus, the transactions lacked economic

substance because they contained no reasonable possibility of

profit exclusive of tax benefits.

No valid business purpose was served by the leasing

transactions. Kanter did not know whether any of the leasing

deals made a profit.

No evidence was presented as to succeeding leases, payments

made by IRA on the long-term notes, or payments received by IRA

from the lessees or the sale of the equipment. No corroborating

financial records to support the substance of the transactions

were provided. No witnesses testified with respect to any

business purpose. Schott did not know about the transactions

other than recognizing her signature. Freeman and Meyers, other

individuals prominently connected to IRA, did not testify.

Gallenberger, who was also associated with IRA and testified on

various aspects of the Kanter business dealings, did not testify

with respect to the Dard, Lexet, and Ben Energy transactions.
 - 513 -

In light of this and the lack of evidence of residual value,

we find that no business purpose could have existed, other than

the creation of tax benefits. IRA presented no persuasive

evidence that it evaluated the transactions in a businesslike

fashion. IRA's decision makers had minimal knowledge of the

computer industry. This is supported by the fact that by the

time IRA would receive the title to equipment, in the late 1980's

for most of the deals, it no longer listed the equipment on its

returns as producing income. IRA never desired the residual

values, only the tax benefits accompanying the purported

agreements.

We agree with respondent that the various intermediaries

used in the transactions (e.g., Horizon or Pluto) were inserted

into IRA's transactions with the leasing companies, e.g.,

FSC/FSAM and O.P.M., purely for tax reasons, and that their

presence served no valid business purpose. In fact, their

presence reflects the tax-avoidance motivations of IRA and serves

to support respondent's determinations that the transactions

lacked substance and constituted nothing more than paper-

shuffling.

In our opinion, IRA's transactions with O.P.M. and FSC/FSAM

were entered into purely for tax purposes and were not supported

by economic substance in the form of a realistic potential for

profit. They must, therefore, be regarded as sham transactions.
 - 514 -

Frank Lyon Co. v. United States, 435 U.S. 561 (1978); Rice's

Toyota World, Inc. v. Commissioner, 81 T.C. 184, (1983). IRA, in

effect, did not purchase computer equipment, but purchased a

package of tax benefits. No evidence of fair market and residual

value or useful life was ever considered prior to consummating

the transactions. The projected residual values at the time the

leases with the lessees or intermediaries terminated were not

established.

Accordingly, since IRA did not acquire an interest in

depreciable property, we hold that it is not entitled to deduct

depreciation on the cost of the equipment or to the claimed

investment tax credits. We also hold that the sham nature of

IRA's transactions precludes any deduction for interest on the

promissory notes.

Second, IRA is not considered the owner of the computer

equipment for Federal income tax purposes because it did not

possess the burdens and benefits associated with ownership. This

is a question of fact to be ascertained from the intention of the

parties as evidenced by written agreements, in view of the

surrounding facts and circumstances. See Grodt & McKay Realty,

Inc. v. Commissioner, 77 T.C. 1221 (1981).

This Court has considered a number of factors having

particular relevance to the analysis of computer sale and

leaseback transactions: (1) Whether legal title passed, (2)
 - 515 -

whether an equity was acquired in the property, (3) whether the

parties treated the transaction as a sale, (4) whether useful

life in excess of the leaseback term and significant residual

value were reasonably expected to exist, (5) whether the contract

of sale created a present obligation on the purchaser to make

payments, (6) whether any other party held a purchase option at

less than fair market value, (7) whether renewal rental at the

end of the leaseback term was set at fair market rent, and (8)

whether the purported owner of the property had a reasonable

possibility to recover his investment from the income-producing

potential and residual value of the equipment. See Torres v.

Commissioner, 88 T.C. 702 (1987). In addition, the presence of

arm’s-length dealing is appropriate to the determination of a

sham. See Estate of Franklin v. Commissioner, 64 T.C. 752

(1975), affd. 544 F.2d 1045 (9th Cir. 1976).

Analysis of the transactional documents shows that IRA had

few, if any, of the rights and privileges normally associated

with legal title. For example, in one transaction, IRA could not

transfer the equipment without first securing the consent of

O.P.M. IRA could not pledge its interest in the equipment as

security for a loan or do anything that would result in the

imposition of a lien, either voluntarily or otherwise. IRA

generally did not assume the obligations of the seller/lessee.

IRA also agreed that O.P.M. could pay off its loan and refinance
 - 516 -

the equipment, and that its interest in the equipment would be

subordinate to that of the replacement lender. O.P.M. was not

required to renegotiate the terms of IRA's note if it could

replace another loan with more favorable financing.

II. Specific Leasing Transactions

The specific computer leasing deals at issue are further

analyzed in connection with the foregoing discussion:

A. Cedilla Invest.-1976 Domestic (O.P.M. Transaction)

The purported equipment purchase, in December of 1976, by

Cedilla Invest. (the predecessor of IRA) was for $1 million.

This was at a time shortly after the property was purchased by

the seller, Pioneer Computer Marketing Corp., on October 14,

1976, for $600,000. No contemporaneous appraisals supporting the

purchase price paid by IRA were presented. The bill of sale is

undated. This indicates a lack of economic substance. Moreover,

since the purchase price is clearly inflated, it lends credence

to respondent's position that this transaction was nothing more

than a sham. See Soriano v. Commissioner, 90 T.C. 44 (1988);

Falsetti v. Commissioner, 85 T.C. 332 (1985); see also Rose v.

Commissioner, 88 T.C. 386 (1987), affd. 868 F.2d 851 (6th Cir.

1989). There was no valid explanation for IRA's agreement to pay

the inflated amount, other than the acquisition of tax benefits.

The promissory note in the amount of $970,000 executed by

Cedilla Invest. purportedly to purchase the equipment was a
 - 517 -

"Nonrecourse Installment" promissory note in favor of O.P.M.

Therefore, Cedilla Invest. had no recourse liability for the

debt. See Rose v. Commissioner, supra. Moreover, the note

contained a provision for deferral and set-off of payments to

O.P.M. by Cedilla Invest. to the extent of and for the amount of

rent that was not paid by O.P.M. This deferral extended to

January 1, 1986. There was little likelihood Cedilla Invest.

would be called upon to satisfy this obligation.

The agreement with O.P.M. included a substitution agreement

permitting O.P.M. to substitute and exchange certain equipment

for that currently being leased. This indicates a retention by

the lessee of control over the property. This fact negates any

claim that IRA obtained ownership of the property.

The sham nature of the transaction is shown by the manner in

which it was purportedly negotiated. Schott was asked to be a

director of IRA, yet knew little, if anything, about its

operations. She executed documents on behalf of Cedilla Invest.

without knowing who prepared the documents or the purpose for

them. Schott did not have an equity interest in the company,

despite the fact that IRA's records indicated at one time that

she was an owner thereof. Mallin executed a document on behalf

of Cedilla Invest. as a director after he had been asked to

become a director by Kanter. Mallin received a commission for
 - 518 -

brokering the transaction which suggests he wore two hats in the

deal.

In view of the sham nature of the transaction, all

deductions and credits associated with this transaction and

claimed by IRA/Cedilla Invest. on its Federal income tax returns

are disallowed.

B. Cedilla Invest. - 1977 Domestic Transaction (Master Lease
Transaction)

This transaction involved the purported purchase by Cedilla

Invest. of various pieces of computer equipment under a master

lease in November 1977. The lease term for each piece of

equipment subject thereto was 108 months. During the term of the

lease, the lessee was responsible for maintaining the equipment

and insuring it for risk of loss or damage. The lessee

maintained the right to sublet the equipment. The purchase was

subject to the interests of lessees (end users) and lienholders.

The purported purchases were paid by cash and the delivery

of "limited recourse" promissory notes. The amount of the

downpayment was 10 percent. All of the promissory notes for the

purchase of the various pieces of equipment were identical in

nature. The notes included a deferral provision which permitted,

in the event the lease was terminated early on account of

default, deferral of payment of the balance due on each of the

notes and any accrued interest until December 31, 1991. This
 - 519 -

deferral was in excess of 13 years. The payment of the debt was

not enforceable or unconditional.

The limited recourse promissory notes included a provision

wherein the payee (the lessee) agreed to look solely and only to

the collateral for the payment of any of the obligations of the

payor under the note. There was no right of the payee to pursue

the payor independently of the collateral.

In view of the lack of economic substance, all deductions

and credits associated with this transaction and claimed by IRA

on its Federal income tax returns are disallowed.

C. Cedilla Invest.-1979 Foreign Transaction (British Aerospace
Transaction)

This transaction involved the purported sale and leaseback

of computer equipment located in England. There are several

intermediary transactions that were involved here. In October

1979, a company named Atlantic Computer Leasing, Ltd., which had

been involved in arranging the leasing transactions for the end

users, consummated a deal with companies called European Leasing,

Ltd., Carena Computers, and Funding Systems International Corp.,

a division of Funding Systems Asset Management. This is the

company with which Uhl was affiliated. The original agreement

provided for the purchase of equipment in the amount of

$2,820,501. The additional equipment was purchased for a price

of $3,042,338. The equipment included three mainframe IBM

computers and associated equipment.
 - 520 -

After Atlantic consummated its agreement with European by

assigning its rights in the equipment, European sold its rights

to Carena, which then transferred its interest in the equipment

to Funding Systems International, which then entered into an

agreement with Pluto Leasing Corporation, a Mallin entity,

delivering the bill of sale in December 1979, to Pluto for the

various computer equipment. Under the purchase, Pluto obtained

FSAM's interest in all of the equipment which was subject to

prior leases made between Carena and others. The price

ostensibly to be paid by Pluto was $6,118,051.

On December 30, 1979, a purported purchase agreement was

executed on behalf of Cedilla Invest. and Pluto, pursuant to

which Pluto delivered a bill of sale in favor of Cedilla Invest.

The purchase price therefor was $6,118,051. The payment

provisions of this agreement included the execution by Cedilla

Invest., in favor of Pluto, of a limited-recourse promissory

note-security agreement in the amount of $5,928,051. Under this

agreement, the interest of Cedilla Invest. in the equipment was

subordinated to the interest of the underlying lessees (including

Funding), the lienholders, and the rights of Atlantic under a

residual agreement Cedilla Invest. entered into regarding the

original purchase of the equipment.

The limited-recourse promissory note contained a provision

for deferral which permitted the payor to defer any sums,
 - 521 -

principal and interest, due under the note, if any amount of rent

due under the lease was not received by the payor as the payments

became due. The deferral allowed the payor, Cedilla Invest., to

defer payment until December 31, 1994, without paying accrued

interest on that deferred amount. Under paragraph 7 of the

agreement, pertaining to the limited recourse obligations,

Cedilla Invest. was personally liable only for the interest and

principal on the note during the times and in the amounts set

forth in schedule A. The amount of recourse obligation as of

January 1, 1988, was zero. The balance of the obligation was

nonrecourse, and the payee looked only to the collateral for

payment.

IRA presented no evidence as to which entity had legal title

to this equipment under the various agreements. The purchase

agreements of Atlantic indicate that, as a part of each of the

lease agreements with Carena, at the end of the lease term, which

was either 5, 6, or 6½ years, depending on the equipment,

Atlantic would make all efforts to obtain legal title to the

equipment so that it could convey the right, title, and interest

in the equipment to the lessee when the end user's lease

terminated. The price to be paid by Atlantic to obtain the legal

title to the equipment was 2 percent of the original value of the

equipment. This indicates that Atlantic had no legal title to

pass through the intermediaries to IRA, other than a future
 - 522 -

interest it would eventually obtain at a price insignificant in

comparison to the purported original purchase price. Thus, no

substantive residual value was extant.

IRA presented no evidence of fair market value, residual

value, or useful life regarding this equipment, other than the

original purchase prices. The recourse obligations with respect

to the liability of IRA were determined as of the date of

occurrence of a default pursuant to attached schedules which

stated that the maximum amount of personal liability was zero.

Moreover, to the extent that any payments of IRA were deferred

because a default in the lease rentals to IRA, such deferred

amounts were not subject to recourse liability. Thus, there was

no real recourse against IRA. The obligations of Funding to

Carena were nonrecourse. Cedilla Invest./IRA did not assume the

obligations. IRA's purported purchase was subject to the rights

of prior lienholders, lessees, and the rights of Atlantic.

The lease between Cedilla Invest. and Funding International

ended on December 31, 1988. As of January 1986, the equipment

used in this transaction, i.e., the IBM mainframe computers,

model Nos. 3031 and 3032, was no longer listed in the computer

price guide, which is the bluebook of used IBM computer prices.

This would indicate that the residual value of the equipment as

of that date was zero.
 - 523 -

The rent to be received by Cedilla Invest. with respect to

this transaction was less than the amount due on the note

including principal and interest and the initial cash investment.

Therefore, the only manner in which IRA could profit would be a

residual value of the equipment that would exceed the cumulative

negative cash-flow and since the expected residual value of the

equipment would be minimal at the end of the end-user lease,

there was little likelihood that IRA would ever recover its

investment or realize a profit.

It is questionable whether IRA ever received the benefits

and burdens of ownership when it consummated the agreement with

Pluto, an entity of Mallin. At most, IRA obtained the future

interest or right to participate in the residual value of the

equipment, rather than a present depreciable interest therein.

This was so because Atlantic had no legal title to the equipment,

only the right to obtain title at a cost of 2 percent of the

original purchase price. Future interests are not currently

depreciable. See Coleman v. Commissioner, 87 T.C. 178 (1986),

affd. without published opinion 833 F.2d 303 (3d Cir. 1987).

That case involved Atlantic Computer Leasing and a lease similar

to those herein. We held that the taxpayer did not have a

depreciable interest in the equipment because the leasing

company, Atlantic, did not have a depreciable interest.
 - 524 -

In view of the foregoing, all deductions and credits

associated with this transaction and claimed by IRA on its

Federal income tax returns are disallowed.

D. IRA-1980 Domestic Transaction (Mini Computer Transaction)

This transaction involved a purported sale of miscellaneous

equipment by FSAM to F/S, an entity affiliated with FSC, to

Horizon, and then from Horizon to IRA. Payment of $870,025 by

IRA was made primarily with a limited recourse promissory note in

the amount of $864,325. The amounts for the payments from IRA to

Horizon were equal to the amounts of the payments owed under the

lease agreement. An agreement was reached between IRA, FSAM, and

Horizon that these payments were to offset each other, so only

bookkeeping entries were made.

The interests of IRA in and to the computer equipment were

subject to the interests of prior lienholders and the underlying

lessee. The leases were assigned to IRA through the use of a

collateral assignment by F/S. The promissory note included a

deferral provision allowing IRA to defer payments on the note,

until December 31, 1995, without any interest accruing on the

deferred amount if, and to the extent, amounts of rent were not

paid to IRA. The equipment could be replaced. The recourse

obligation under those provisions in the note provided that

Horizon had recourse against IRA as of January 1, 1989, in the

amount of zero dollars.
 - 525 -

Under the IRA/Horizon leasing transaction, the total cash

investment of IRA was less than the rent to be received

therefrom. The loss was $65,940.21. There was no evidence of

residual value or useful life presented. No business purpose was

set forth. The transaction lacked economic substance. The long-

term debt was not valid. Once again an intermediary was used for

no good reason. The transaction was a sham.

In view of the foregoing, all deductions and credits

associated with this transaction and claimed by IRA on its

Federal income tax returns are disallowed.

E. IRA-1980 Foreign/Domestic Transaction (Alfred Teves
Transaction)

This transaction involved a purported purchase agreement

between Funding International and Funding Systems International

GmbH, pursuant to which Funding International purchased the

equipment for $931,321. It is unclear what property was being

sold because duplicate schedules of certain equipment contained

two addresses. Thereafter, Funding International purportedly

sold the property to Horizon. The purchase price in that

agreement was $4,276,701 and included additional equipment

located in Belgium. Thereafter, Horizon and IRA entered into an

agreement for sale of the property to IRA on which the payments

were identical to the amounts payable under the Funding/Horizon

agreement. The payments were circular.
 - 526 -

The purchase provisions of the IRA/Horizon agreement

included a limited recourse promissory note issued by IRA in

favor of Horizon. This promissory note included deferral

provisions in favor of IRA. The sum could be deferred until

December 31, 1995. Several intermediaries were used. At the

time IRA would receive the equipment, it would have no residual

value.

In view of the foregoing, all deductions and credits

associated with this transaction and claimed by IRA on its

Federal income tax returns are disallowed.

F. Cedilla Invest.-"Lexet Transactions", "Ben Energy
Transactions", and "Dard Systems Transactions"

These transactions consist of seven (two Lexet, two Ben

Energy, and three Dard Systems) purported purchases and

leasebacks of computer equipment and peripherals manufactured by

IBM, Wang, and others. All of these transactions took place on

December 22, 1986.

The only documents presented by IRA in connection with these

transactions were seven purchase agreements, seven bills of sale,

seven short-term promissory notes, and seven long-term "limited

recourse" promissory notes. No other transactional documents

were produced by IRA, such as equipment appraisals, leases,

economic forecasts, related correspondence, legal opinions, rent

payment schedules, loan payment schedules, checks (negotiated or

otherwise) evidencing payments of purchase price or rents or
 - 527 -

loans, or records establishing the existence or actual location

of the equipment at any time during the subject leases. The

inference to be drawn from IRA's failure to produce or present

these critical documents is that such materials never existed or,

if they did exist at one time, their production would have

provided evidence unfavorable to IRA's positions. See Wichita

Terminal Elevator Co. v. Commissioner, 6 T.C. 1158, 1165 (1946),

affd. 162 F.2d 513 (10th Cir. 1947).

Moreover, a review of the 28 exhibits related to these

transactions indicates that they all followed the identical

format and utilized the same form documents as the other

transactions discussed at length.

As with the other computer leasing transactions at issue

here, these seven transactions utilized invalid debt because the

long-term "limited recourse" promissory notes effectively

shielded IRA from ever having to make any payments on the notes.

Although the specific deferral provisions were eliminated from

these notes--presumably in response to challenges thereto by

respondent in connection with earlier (i.e., 1976 through 1980)

transactions--each of the long-term "limited recourse" promissory

notes contained the same provisions with respect to the limited

liability of IRA. Section 10 ("Limited Recourse") sets forth

IRA's "Recourse Obligations" and basically states that

IRA/Cedilla Invest. is only personally liable to the extent of
 - 528 -

the outstanding amount of the note or the lesser of zero.

Section 10 also sets out IRA's "Nonrecourse Obligations".

Everything in excess of the recourse obligations--here the entire

amount of the loan--was nonrecourse, and with respect to which

amount "the payee shall look solely and only to the Collateral

for the payment and performance."

These long-term "limited recourse" promissory notes contain

provisions similar to those present in the other transactions,

i.e., restrictions were imposed on the transfer of the equipment,

and the interest of Cedilla Invest. in the equipment was

subordinated to the interests of the underlying lessees.

Accordingly, and as with the other transactions, IRA did not have

the true benefits and burdens of an owner of the equipment for

Federal tax purposes. IRA failed in its burden of proving that

any amounts representing the purchase price were actually paid

over, that legal title to the equipment never passed to IRA, that

the underlying equipment really existed or was placed in service,

and that any of the transactions were even consummated. Based on

the totality of the evidence presented, all IRA established, with

any certainty, is that it had a corporate representative execute

some (minimal) transactional documents which provided a claim for

substantial tax benefits.
 - 529 -

In view of the foregoing, IRA is not entitled to any

deductions, credits, or losses associated with these purported

transactions.

G. Equitable Leasing

This is another computer leasing transaction purportedly

engaged in by IRA. A reference is made to it in the summary

schedules of a witness for IRA. While respondent does not agree

with the numbers delineated in the summary schedules, it appears

that this transaction was considered in computing the tax

liability of IRA for the taxable year ended December 31, 1980.

No facts to support the basis for the income, deductions,

credits, or losses, which apparently were claimed in connection

with this transaction, were presented by IRA. Since IRA had the

burden of proof on this issue, we sustain respondent's

determinations of disallowance with respect to this transaction.

Finally, the long-term promissory notes executed by IRA to

finance the purported computer sale and leaseback transactions do

not constitute valid indebtedness because there was little

possibility that IRA would ever be required to make the payments

due.

IRA's long-term promissory notes in these various

transactions were neither unconditional nor enforceable. They

are not unconditional because the promise to pay in most of the

notes was expressly contingent, by virtue of the deferral
 - 530 -

provisions of the notes, on the payment of rent by the respective

lessees.

Moreover, although the equipment was to serve as collateral,

the equipment was likely to be worthless by the time the

obligations were to be enforced (i.e., the deferral dates or the

end of the leases between IRA and the lessees). The notes are

not enforceable because there was no possibility that the payor,

IRA, would ever be compelled to use its own funds or surrender

valuable property in satisfaction of the obligations.

Accordingly, the notes did not represent genuine debt obligations

and are disregarded for Federal income tax purposes.

The Commissioner was successful in attacking the validity of

a long-term purchase money note executed as part of a sale and

leaseback of computer equipment in Bussing v. Commissioner, 88

T.C. 449, Supplemented by 89 T.C. 1050 (1987). The facts of that

case reflect a transaction similar to those here involved. A.G.

sold computer equipment through a middle company, Sutton, to five

investors, including the taxpayer, and then leased the equipment

back from the taxpayer's investment group. The investors'

payments on their long-term note to Sutton were financed entirely

by the rent due from A.G. In the event of a default by A.G. on

the lease, the principal and interest payments on the note to

Sutton were deferred to December 31, 1991, without the accrual of

any additional interest. We found that Sutton had been inserted
 - 531 -

into the transaction solely for tax purposes and that the real

parties at interest were A.G. and the taxpayer. Since A.G.'s

rent always equaled or exceeded the monthly payments on the long-

term note, any claim by A.G. on the note would be fully offset by

the investors' claim against A.G. for unpaid rent. Therefore,

the taxpayer was effectively protected from ever having to make

any payments on its debt obligation. Accordingly, we held that

the note did not represent genuine indebtedness or represented

that the debtor was not at risk. See id.; see also Levien v.

Commissioner, 103 T.C. 120, 126 (1994) (circularity of payments

means the debtor is not at risk), affd. 77 F.3d 497 (11th Cir.

1996).

Some of IRA's long-term notes contain several of the same

features which this Court found objectionable in Bussing. These

features were a deferral of the debt in the event of nonpayment

of rent, a debt obligation effectively canceled by an offsetting

liability for rent because of the limited recourse nature of the

note, and creditors whose presence served no valid purpose and

who had no demonstrable intention of enforcing the debt

obligation. The real parties to the debt transactions here are

IRA and FSC/FSAM and not Horizon, Pluto, or Knight. IRA's notes

are invalid in form as well as in substance.

In HGA Cinema Trust v. Commissioner, T.C. Memo. 1989-370,

this Court rejected the validity of indebtedness used to finance
 - 532 -

equipment leasing transactions. The long-term notes used in HGA

Cinema Trust contained deferral provisions similar to those

involved herein. In fact, the only significant difference, in

most of the deals, is that instead of an indefinite offset

provision, the notes contain the following variation. The

deferral provisions are to be read in light of a "limited"

recourse obligation provision, the amount of which declines over

the years. However, by the time the deferred amounts are due--a

time which is well after the original lease--the scheduled

recourse obligation is zero. In some instances the recourse

obligation is zero from the outset. In another instance the

recourse is limited only to the value of the collateral.

Further, the residual value, regardless of the scheduled

obligation, and even under the most generous of estimates, is

also zero.

There is clearly a circularity of offsetting rent and debt

obligations in the provisions, and, generally, the only

difference from the notes in HGA Cinema Trust is the substitution

of a valueless recourse obligation provision for the offset and

discharge provision. There was little likelihood IRA would ever

be called on to pay the liability set forth in each of the long-

term notes. Further, there was no testimony or other evidence

presented at trial that it ever did. The intent of the limited

recourse provision and the deferral provision was the same as the
 - 533 -

deferral and offset provisions, i.e., to ensure that IRA would

never be liable for the principal amount of the notes, along with

any accrued interest.

In HGA Cinema Trust, the Court specifically rejected the

taxpayers' allegations that the notes were valid because of the

potential effects of FSC's and O.P.M.'s bankruptcies. Some of

the leases herein were modified in connection with the bankruptcy

proceedings, but, as in HGA Cinema Trust, the bankruptcy

modification agreements present in this case have no legal

significance to the validity of the indebtedness, and are

therefore disregarded.

We realize that this Court has rejected the Commissioner's

challenges to the validity of long-term purchase money notes in

some cases involving equipment sales and leasebacks. What is

notable about these cases, however, is not the result, but the

Court's rationale for finding the notes therein to have been bona

fide. For example, in Gefen v. Commissioner, 87 T.C. 1471, 1494

n.15 (1986), we found that the partnership's note was a genuine

debt because the partnership was responsible for the monthly

payments, regardless of whether or not its lessee paid the rent.

In Cooper v. Commissioner, 88 T.C. 84 (1987), the Court, in

upholding the validity of the note, observed that the terms of

the note did not require payment solely out of rental income.

IRA's long-term notes, unlike the notes in Gefen and Cooper,
 - 534 -

contain an express term conditioning liability upon the payment

of rent. Thus, this situation is distinguishable from other

cases where we have upheld the validity of the long-term debt.

In our view, there was no possibility that IRA would ever

pay the long-term notes without receipt of the prior payments of

rent from the lessees. IRA's transactions were carefully

structured in such a way so as to preclude the possibility of any

additional financial exposure, while enabling it to claim

sizeable tax deductions and credits at a minimum cost. We

recognize that the payment of the full amount of 1 month's rent,

followed by IRA's failure to make the required principal and/or

interest payment on the note, could cause the entire unpaid

principal, and accrued but unpaid interest, to become immediately

due and payable. Failure to pay the debt, however, does not

permit the lessee to stop paying the rent. If the lessee decided

to withhold the next month's rental payment, such failure would

trigger the deferral provisions of the notes, leaving the lessee

or intermediary at that time, with at best a claim against IRA

for 1 month's principal and/or interest, rather than the full

amount of the debt. Therefore, the mere possibility that IRA’s

liability on the notes could be accelerated, which in fact never

happened, does not validate the debt, considering all of the

facts and circumstances. IRA has simply not carried its burden

of proving that the long-term notes were valid.
 - 535 -

IRA acquired the equipment subject to pre-existing liens and

leases and the rights and interests of the lessees and

intermediaries under their respective agreements. Since the

equipment was so heavily encumbered, the value of IRA's equity

interest was not sufficient incentive for it to pay the notes in

the absence of the payment of rent. Estate of Franklin v.

Commissioner, supra. Furthermore, IRA would have no incentive

for paying the notes on the respective deferral dates because the

equipment would have had little, if any, value at that time.

A note which does not represent genuine indebtedness can

neither be included in basis nor support a deduction for interest

expense. See Knetsch v. United States, 364 U.S. 361 (1960);

Deegan v. Commissioner, 787 F.2d 825, 827 (2d Cir. 1986).

Therefore, the tax effect of our holding on this issue is

twofold. First, the principal amounts of the long-term notes

must be eliminated from IRA's depreciable basis. Second, all

deductions for interest, including the interest prepayments

represented by the short-term notes to the various entities, are

disallowed.

Accordingly, we sustain respondent's determinations in all

respects as to this issue.58

58
In view of our holding on this issue, sustaining
respondent's determination that the computer leasing transactions
IRA or Cedilla Invest. entered into lacked economic substance,
the Court need not decide the issue of IRA's income adjustments
(continued...)
 - 536 -

Issue 23. Whether IRA is Entitled to a Claimed Loss on Form 4797
of $1,073,835 for 1988

FINDINGS OF FACT

IRA reported, on line 9 of its Federal income tax return,

Form 1120 for 1988, a net loss "from Form 4797" in the amount of

$1,073,835.59 No Form 4797 was attached to the original return

filed with respondent, nor was a copy of the form subsequently

presented to respondent or introduced into evidence at trial.

(...continued)
for 1986, 1987, 1988, and 1989 from its purported transfer of
certain computer equipment to HICIP Partners. On brief,
respondent acknowledges that the HICIP Partners' income
adjustments represent an alternative position respondent took in
the event the Court found in favor of IRA on the sale/leaseback
transactions. As IRA or Cedilla Invest. acquired no ownership
interest in the equipment for tax purposes, no gain or loss would
be realized by them for 1986 through 1989 from their later
"transfers" of some of the equipment to HICIP Partners.
Similarly, in view of our holding sustaining respondent's
determination that the purportedly recourse long-term notes IRA
or Cedilla Invest. issued in the leasing transactions were not
valid debts, the Court need not decide the issue of whether IRA
realized discharge of indebtedness income upon its and Cedilla
Invest.'s contribution of certain computer equipment to the
IRAUTO partnership. On brief, respondent acknowledges that the
discharge of indebtedness adjustment represented an alternative
position respondent took in the event the Court sustained IRA.
Because IRA and Cedilla Invest. issued no valid long-term
indebtedness in connection with the leasing transactions, no
discharge of indebtedness income attributable to such
"indebtedness" was realized by them on their contribution of the
equipment to the IRAUTO partnership.
59
Form 4797 is entitled "Sales of Business Property" and,
among other things, is the form used to report the sale or
exchange of property used in a trade or business, depreciable and
amortizable property, and the disposition of noncapital assets.
 - 537 -

In the notice of deficiency, respondent disallowed the loss

on the grounds that IRA did not establish a basis in the assets

sold or disposed of, that IRA failed to prove that the

transaction had economic substance, and that the sale was to one

or more related parties and was, therefore, subject to the

provisions of section 267 limiting the deduction of losses on

such transactions. The claimed loss arises out of a sale by

Decision Holdings Corp. (Decision Holdings), a subsidiary of

IRA.60

Decision Holdings was incorporated under the laws of the

State of Delaware on November 3, 1988. It initially was named

Tokyo Stress Management Co., which was changed to Decision

Holdings Corp. on November 30, 1988, prior to the issuance of any

of the corporation's stock.

Before December 1, 1988, Decision Holdings was inactive and

had never been capitalized. Its officers were Gallenberger,

secretary, and Freeman, president.

In December 1988, Kanter devised and implemented a series of

transactions to generate a $1,073,835 loss for IRA. On or about

December 1, 1988, IRA transferred its 100 shares of the common

stock of Zeus, its 1,200 shares of class A preferred stock of

Cedilla Invest., and $60,000 cash to Decision Holdings in

60
The income, expenses, and losses of Decision Holdings were
reported on the consolidated Federal income tax return filed by
IRA for the year at issue.
 - 538 -

exchange for 850 shares (85 percent) of the corporation's common

stock. Also on December 1, 1988, TG Associates Limited

Partnership (TG), a Connecticut limited partnership transferred

to Decision Holdings a third-party installment promissory note of

$3,389,592, its interests and obligations as lessee under a

lease, and its rights (but not obligations) under a remarketing

agreement. In turn, Decision Holdings transferred $51,000 cash

to TG and 150 shares (15 percent) of Decision Holdings common

stock.

The lease transferred by TG to Decision Holdings is dated

August 29, 1983, and was an agreement between Decisions Inc., a

Florida corporation, as lessor, and TG, as lessee, for an 84-

month term lease of certain computer equipment and peripherals.

The specific equipment that is the subject of the lease was not

used by TG but was subleased to various end users.

The installment promissory note was dated August 29, 1983

(the note). The payor was Solutions, Inc. (Solutions), a

Delaware corporation. TG was the payee, the note was in the

amount of $3,389,592 principal plus interest at the rate of 14

percent per annum and was payable over an 84-month period

commencing September 1, 1983, and continuing through August 1,

1990. The note states that Solutions and TG were parties to a

purchase agreement of the same date, pursuant to which TG sold

equipment to Solutions. Unless the context of the note indicated
 - 539 -

otherwise, terms defined in the purchase agreement had the same

meaning in the note. The note provided:

In the event * * * [Solutions] pays any of the Debts
(which, upon the occurrence and continuation of an
Event of Default under the Lease and upon notice * * *
to [TG], * * * [Solutions] shall have the right, but
not the obligation so to do) whether pursuant to the
terms of Liens or otherwise, all amounts so paid shall
be deemed to be prepayments under this Note in such
manner as to principal and interest as * * *
[Solutions] shall elect.

The lease referred to in that provision of the note is not

in the record. Similarly, the remarketing agreement transferred

from TG to Decisions Holding is not in the record.

On December 30, 1988, Decision Holdings entered into a "Sale

and Assignment Agreement" whereby Decision Holdings ("seller")

transferred the installment promissory note, interests and

obligations as lessee under the lease, and rights under the

remarketing agreement, plus $3,000, cash to Autochthon

Associates, L.P., a Delaware limited partnership (as "buyer"), in

exchange for no consideration other than the assumption of

certain purported liabilities in connection with the lease. As a

result of the transaction Decision Holdings claimed a $1,073,835

loss which respondent disallowed on the 1988 consolidated income

tax return filed by IRA.

The partners of Autochthon Associates, L.P., and their

contributions to the partnership, were as follows:
 - 540 -

(1) The general partner was Autochthon Administration, Inc.

--($10); and

(2) the limited partners were the Penobscot Nation-($989);

and Autochthon Investment, Inc.--($1). The president of

Autochthon Administration, Inc., was an associate of Mallin.

OPINION

IRA contends that it and the TG limited partnership's

transfer of assets to Decision Holdings qualifies for

nonrecognition treatment under section 351. IRA claims that the

cost or basis of the interests transferred by TG to Decision

Holdings as of December 1, 1988, was $1,091,641. Thus, it is

asserted that Decision Holdings, under section 362, had a

carryover of TG's basis in the assets the limited partnership

transferred to it, so that Decision Holdings realized a

$1,073,835 loss on the sale of those assets to Autochthon. IRA

further maintains that (1) respondent's argument that section 351

is inapplicable to the transaction was not raised in the notice

of deficiency, and such issue is not properly before the Court;

(2) there was a business purpose for the transaction; and (3)

Decision Holdings' basis in the assets it subsequently sold was

substantiated.

Respondent contends that IRA engaged in the purported

section 351 transaction for tax avoidance purposes in order to

enable it to claim a loss in excess of $1 million from Decision
 - 541 -

Holdings' sale of the assets a short time later. Respondent

argues that IRA was seeking only to obtain a large potential loss

deduction for itself. It is pointed out that IRA received 85

percent of Decision Holdings' shares in exchange for $60,000,

whereas the TG limited partnership received $51,000 and 15

percent of Decision Holdings' shares in exchange for the assets.

Respondent also contends that IRA failed to substantiate Decision

Holdings' claimed basis in the assets.

We agree with respondent. We view the two-step transaction

involving Decision Holdings as an economic sham and disregard it

for Federal income tax purposes.

The step transaction doctrine provides that, when separate

steps are integrated parts of a single plan, the separate steps

are disregarded, and the entire plan is viewed as a unit for

purposes of determining the tax consequences. See Helvering v.

Alabama Asphaltic Limestone Co., 315 U.S. 179 (1942); McDonald's

Restaurants, Inc., v. Commissioner, 688 F.2d 520, 524-525 (7th

Cir. 1982), revg. 76 T.C. 972 (1980). In general, a series of

steps will be integrated into a single plan if the steps are

interdependent, which determination is made by reference to

whether the legal relationships created by any one step would

have been fruitless without the completion of the entire series,

or whether the component parts of the transaction were part of a

single transaction intended to reach the ultimate result.
 - 542 -

Section 1011 provides that the adjusted basis for

determining the gain or loss from the sale or other disposition

of property is the basis determined under section 1012, adjusted

as provided in section 1016. Section 1012 provides that the

basis of property is the cost of the property and under section

362(a) such basis in a transferor carries over to a corporation

where such property is contributed to the corporation for stock

under section 351.

The transaction involved here is a classic example of loss-

buying. It was a premeditated and abusive tax scheme structured

by Kanter for the sole purpose of obtaining an enormous and

unjustified loss deduction on behalf of his controlled

corporation, IRA. IRA became involved in the matter at the

direction of Kanter, who acknowledged that the transaction at

issue was hurried and there had been no due diligence with

respect thereto.

The entire scheme--a purported section 351 exchange and

subsequent disposition (sale and assignment)--took less than 30

days. The reality of the transaction is that IRA paid $60,000

cash on December 1, 1988, for an ordinary loss supposedly

realized on December 30, 1988, in the amount of $1,073,835 that

was claimed on IRA's 1988 Federal income tax return.

IRA failed to present any evidence to support the legitimacy

of the installment promissory note or that the note represented
 - 543 -

bona fide indebtedness. The note was clearly tied to a

sale/leaseback tax shelter transaction. No records were

introduced to establish that principal or interest payments were

made at any time, or that the principal had not been prepaid

directly or through the "Event of Default" under the lease, nor

was any testimony provided by either of the parties to the note

(TG or Solutions). There is no evidence that the note had any

value at the time of the transfer to Decision Holdings.

IRA also failed to present any evidence to support the

legitimacy of the lease agreement, such as records establishing

that lease payments were being made, or had ever been made, nor

was any evidence introduced regarding the underlying computer

equipment and end users, including any documents to establish

that the equipment had any value at all at the time of the

transfer to Decision Holdings.

There is no evidence that Autochthon ever made any payments

in connection with the liabilities it purportedly assumed in

connection with the sale and assignment entered into with

Decision Holdings or received any payments in connection with the

installment promissory note transferred to it.

In our opinion, Kanter simply activated a shelf corporation

(Decision Holdings) for the limited purpose of utilizing the tax-

free exchange rules set forth in section 351 and facilitating

related transfers. No evidence was presented that Decision
 - 544 -

Holdings engaged in any business activities. Kanter orchestrated

the series of transactions to create phony losses for IRA.

No one who had been an officer or director of Decision

Holdings at the time of the transactions provided any testimony

in connection with this issue at the trial. IRA did not present

a general ledger, cash receipts journal, or cash disbursements

journal in connection with Decision Holdings for 1988.

Kanter's testimony regarding his "having to do the deal in a

hurry" is ambiguous at best and provides no credible explanation

as to why a seasoned investor would get into a supposedly profit-

motivated deal on December 1, without "really doing any due

diligence", and then dispose of the assets 29 days later at a

loss without any significant intervening events. It seems that

the only hurry on Kanter's part was to finish the deal before the

end of the tax year so that IRA could take advantage of a loss of

more than $1 million.

Accordingly, we hold that the claimed loss deduction was

correctly disallowed by respondent because the transactions

giving rise to the loss had no independent economic substance and

were entered into solely for tax reasons. Therefore, IRA is not

entitled to the claimed loss deduction.
 - 545 -

Issue 24. Whether IRA Is Entitled to a Charitable Contribution
Carryover Deduction for 1983

OPINION

In the notice of deficiency for 1983, respondent determined

that IRA was not entitled to a charitable contribution carryover

in the amount of $203. Because the charitable contribution

deductions were allowed in prior years, there was no carryover

from 1982 to 1983. IRA did not introduce any evidence on this

issue. Therefore, we sustain respondent's determination.

Issue 25. Whether IRA Is Entitled to Certain Claimed Capital
Losses for 1985

FINDINGS OF FACT

On its Federal income tax return for 1985, IRA claimed

capital losses of $766,566 on the purported sales or other

dispositions of certain assets as follows:

Gross
Date Date Sale
Description Acquired Sold Price Basis Loss
Brajda's 5/14/85 3/18/85 $19,388 $58,251 ($38,863)
N/R Funding Sys. 7/82 12/01/85 20,000 91,988 (71,988)
N/R Tanglewood 7/11/80 12/01/85 10,000 350,000 (340,000)
N/R LBG 9/83 12/01/85 10 39,500 (39,490)
N/R Sherwood 10/84 12/01/85 1,000 47,925 (46,925)
U.S. Mineral 7/13/81 12/01/85 500 87,700 (87,200)
Comp. Container 2/25/83 12/01/85 25,000 115,000 (90,000)
Modular Power 3/18/83 12/01/85 100 12,200 (12,100)
Forenergy 12/83 12/01/85 5,000 45,000 (40,000)

Total 80,998 847,564 (766,566)

In the notice of deficiency, respondent disallowed the

claimed losses on the grounds that IRA did not establish its

basis in the assets sold or disposed of and IRA did not
 - 546 -

demonstrate that the transactions had any substance. Respondent

further determined that the sales were to a related party and

were subject to section 267, which disallows losses between

related parties.61

As of June 24, 1985, IRA's general ledger reflected a note

receivable in the amount of $122,500 owing by Funding Systems.

It further reflected that, on that same date, IRA received

payments, leaving a $91,988 balance due on the receivable.

LBG Properties, Inc. (LBG), is a subsidiary of IRA. IRA's

general ledger reflected that IRA had had a note receivable of

$39,500 owing by LBG.

Sherwood Associates (the Sherwood partnership) is a

partnership in which IRA was a partner. IRA's general ledger

reflected that IRA had a note receivable of $47,925 owing by the

Sherwood partnership.

Tanglewood Properties, Inc. (Tanglewood), is a subsidiary of

Holding Co. Prior to 1981, Holding Co. had paid or transferred

$350,000 to Tanglewood. On its books, Holding Co. recorded this

transaction as a note receivable owing by Tanglewood. On or

before August 31, 1981, IRA acquired the Tanglewood receivable

61
Respondent conceded the adjustments relating to the capital
losses claimed on the sales of stock of Brajda's, U.S. Mineral,
Composite Container, Modular Power, and Forenergy. The remaining
adjustments are in dispute.
 - 547 -

from Holding Co. in exchange for a receivable owing by IRA to

Holding Co.

Pursuant to Kanter's instructions, on December 1, 1985, IRA

sold the receivables due from Tanglewood, LBG, and Sherwood to

Kanter for $10,000, $10, and $1,000, respectively, and sold the

receivable due from Funding Systems to Holding Co. for $20,000.

With respect to each of the sales, Kanter determined the sales

price. The sale prices were not determined by arm’s-length

negotiations.

Neither Kanter nor Holding Co. paid cash to IRA for the

receivables. Instead, receivables due from Kanter and Holding

Co., in the amounts of the respective sale prices of the

receivable, were recorded through adjusting journal entries on

the books of IRA. The sole purpose of the sales was an attempt

by Kanter to provide a basis for IRA to claim a deduction for

Federal income tax purposes.

According to IRA's general ledger, on February 19, 1986, the

$39,500 lent to LBG by IRA and the $47,925 lent to Sherwood by

IRA was repaid to IRA in full. On February 28, 1986, Tanglewood

repaid $6,000 of its loan from IRA, and on June 24, 1986, IRA

received repayments on the Funding Systems note in the amounts of

$10,000, $4,500, and $10,000. The payments from Funding Systems

were credited to Holding Co. by an adjusting journal entry on

IRA's general ledger. The payments from Sherwood and LBG were
 - 548 -

paid to Kanter. On his 1986 return, Kanter reported $46,925

($47,925 - $1,000) as income from loan proceeds from the Sherwood

payment and $39,480 ($39,500 - $20) as miscellaneous income from

the LBG payment.

A foreclosure action was filed against LBG. The litigation

of the foreclosure was not completed until at least 1988. During

1988, LBG was still in existence and was receiving bills from at

least one creditor, Payton and Rachlin.

Tanglewood filed a voluntary petition in bankruptcy under

chapter 11 during May 1990.

OPINION

With respect to IRA's claimed "sales" of the notes

receivable from Funding Systems, Tanglewood, LBG, and Sherwood to

Holding Co. and Kanter, evidence that the "sales" took place

primarily consists of adjusting journal entries on the books of

IRA that credited these receivables and debited "notes

receivable" owing by Holding Co. and Kanter. As the adjusting

journal entries show, neither Holding Co. nor Kanter paid cash

for these notes at the time of "sale". In 1986, repayments of

the notes were made to IRA rather than Kanter, who allegedly had

bought the notes on December 1, 1985. Thus, we think IRA failed

to establish that sales of the notes actually took place, as

evidenced by these bookkeeping entries. See J.G. Boswell Co. v.
 - 549 -

Commissioner, 34 T.C. 539, 545 (1960), affd. 302 F.2d 682 (9th

Cir. 1962).

Moreover, the transactions did not establish bona fide

losses for Federal income tax purposes. Kanter testified that

the purpose of IRA's purported sale of the Funding Systems note

to Holding Co. was to "establish the loss in the manner I have

described before." He testified earlier that he had problems

getting the Internal Revenue Service to allow deductions for

items that he thought were worthless, so he decided the best way

was to sell a note to establish a loss.

IRA was owned by BRT, the beneficiaries of which were

members of Kanter's family. Holding Co. was partially owned by

Kanter and BRT. Kanter was counsel to IRA and Holding Co. and,

at various times, was also an officer or director. There is no

evidence that anyone, other than Kanter, had a role in

establishing the sale prices for the notes. Kanter acknowledged

that he "largely determined" the sale prices for the notes.

Hence, the sale prices were not determined by arm's-length

negotiations.

Kanter's testimony regarding the "sales" further indicates

their lack of economic substance. With respect to the Funding

Systems note receivable, he testified, on direct examination,

that Funding Systems had filed for bankruptcy, that he did not

remember the exact date, but thought it was in the early 1980's,
 - 550 -

and that, at some point, Funding Systems came out of bankruptcy

and the note was worthless. On cross-examination, Kanter

testified that the note was thought to have a value of $20,000 at

the time it was "sold" to Holding Co. In fact, IRA received

repayments on the Funding Systems note totaling $24,500 on June

24, 1986. Kanter admitted that the sale price of the Funding

Systems note was not based on an appraisal, a legal opinion of

those involved in the proceedings, balance sheets of Funding

Systems, or any type of bona fide analysis. He stated that the

purpose of the "sale" was to establish a loss for tax purposes.

This testimony does not establish the value of the note at the

time of "sale".

With respect to the Tanglewood note, Kanter testified that,

by the time IRA wrote off the Tanglewood loan, "it was clear that

there would be no assets available to pay this particular

obligation," yet he purportedly paid $10,000 for the note. If,

in 1985, it appeared that there would be no assets from which to

collect the note, it was not explained why Kanter was willing to

pay $10,000 for the note. Moreover, Kanter's testimony that

there were no assets to repay this obligation is contradicted by

Tanglewood's repayment of $6,000 to IRA in February 1986. This

evidence indicates that the $10,000 sale price was an arbitrary

figure determined by Kanter that had no relationship to the fair

market value of the note in 1985. We also note that this is the
 - 551 -

same note that Kanter subsequently "sold" to Windy City for $100

on December 22, 1987.

Contrary to Kanter's testimony that there was no chance of

recovery on the LBG note, IRA's 1986 general ledger shows that

the $39,500 lent to LBG was repaid in full to IRA on February 19,

1986. This evidence indicates that the $10 sale price was an

arbitrary figure determined by Kanter that had no relationship to

the fair market value of the note in 1985 and that the sale to

Kanter was not entered into for profit by IRA but was an attempt

to establish a basis to claim a loss for tax purposes.

With respect to the Sherwood note, Kanter testified that the

"note was written off because there was no opportunity and no

chance of recovery", but he purportedly paid $1,000 for it. If,

in 1985, it appeared that there would be no assets from which to

collect the note, Kanter should not have been willing to pay

$1,000 for the note. In fact, the evidence shows that the note

was not worthless. Contrary to Kanter's testimony that there was

no chance of recovery on the Sherwood note, IRA's 1986 general

ledger shows that the $47,925 lent to Sherwood was repaid in full

to IRA on February 19, 1986. The fact that the loan was repaid

in full on February 19, 1986, shows that the note was not

worthless in 1985. This evidence indicates that the $1,000 sale

price was an arbitrary figure determined by Kanter that had no

relationship to the fair market value of the note in 1985 and
 - 552 -

that the sale to Kanter was not entered into for profit by IRA,

but was an attempt to establish a 1985 loss for tax purposes.

Given the fact that IRA and Holding Co. were owned by trusts

for the benefit of Kanter's family, that Kanter controlled the

management of IRA and Holding Co., that he largely determined the

sale prices, that the values placed on the notes by Kanter were

contradicted by other evidence, that the sale prices were nominal

compared to the face amount of the notes, and that the admitted

purpose of the sales was to establish losses for tax purposes, we

conclude that the "sales" (if they took place) lacked economic

substance and, therefore, did not constitute identifiable events

for purposes of loss recognition.

As confirmed by Kanter's testimony, the "sales" were merely

attempts by IRA to claim deductions for alleged worthlessness or

alleged partial worthlessness of debts without meeting the

requirements of section 166. If the Court were to recognize such

practices as bona fide sales for purposes of loss recognition,

section 166 would be substantially undermined. The scheme

employed, as a purported sale, does not establish the amount, if

any, of loss incurred; consequently, the losses purportedly

realized are not recognized.

In addition, we hold that IRA failed to establish that the

notes receivable were not sold to related parties within the

meaning of section 267.
 - 553 -

With respect to the losses claimed on the sales of IRA's

notes receivable from Tanglewood, LBG, and Sherwood, IRA's

adjusting journal entries and Kanter's testimony indicate that

these notes receivable were sold by IRA to Kanter. IRA failed to

establish that Kanter did not indirectly own more than 50 percent

of IRA, and, therefore, the claimed losses are not allowable.

See sec. 267(a) and (b)(2). In fact, the evidence indicates

that Kanter did indirectly own more than 50 percent of IRA within

the meaning of section 267(b)(2). During 1985, the sole

shareholder of IRA was BRT, and the beneficiaries of BRT were

members of Kanter's family within the meaning of section

267(b)(1) and (c)(4). Stock owned by BRT is considered as being

owned proportionately by its beneficiaries, members of Kanter's

family. See sec. 267(c)(1). Stock owned directly or indirectly

by members of Kanter's family is considered owned by him. See

sec. 267(c)(2). Since the beneficiaries of BRT are considered to

own the stock of IRA, the beneficiaries of BRT are members of

Kanter's family, and Kanter is considered as owning the stock

owned by members of his family for purposes of section 267(b)(2),

Kanter owned more than 50 percent of IRA. Therefore, IRA's

claimed losses on its sales of the Tanglewood, LBG, and Sherwood

notes receivable to Kanter are not allowable. See Pomeranz v.

Commissioner, T.C. Memo. 1980-36 (disallowing a loss on a sale of

stock by the taxpayer to a corporation owned by a family trust
 - 554 -

for the benefit of members of the taxpayer's family on the ground

the taxpayer was deemed to own the shares held by the

beneficiaries of the trust under section 267).

With respect to the loss claimed on the sale of IRA's note

receivable from Funding Systems, IRA's adjusting journal entries

and Kanter's testimony indicate that this note receivable was

sold by IRA to Holding Co. IRA failed to establish that IRA and

Holding Co. were not members of the same controlled group within

the meaning of section 267(b)(3), and, therefore, the claimed

loss is not allowable. See sec. 267(a) and (b)(3). In fact, the

evidence shows that IRA and Holding Co. were members of the same

controlled group within the meaning of section 267(b)(3).

As previously stated, IRA was owned by BRT, the

beneficiaries of which were members of Kanter's family. The

corporate minutes of Holding Co. show that the shareholders of

Holding Co. were Kanter, BRT, and various other trusts. Kanter

was at times president of Holding Co. Holding Co. was a client

of Principal Services.

Kanter directed moneys and other personal service income

(such as trustee fees earned by him as trustee of the Hi-Chicago

Trust) to Holding Co. The facts show that, like IRA, Holding Co.

was owned by members of Kanter's family and that, under the rules

of attribution set forth in section 1563(d) and (e), the same

five or fewer persons owned 50 percent or more of IRA and Holding
 - 555 -

Co. Therefore, IRA and Holding Co. were members of a brother-

sister controlled group under section 1563(a)(2), which is

incorporated by reference in section 267(b)(3) and (f).

Finally, IRA failed to establish that any of the alleged

debts became wholly worthless in 1985, and, consequently, it is

not entitled to bad debt deductions.

Pursuant to section 166(a)(1), a deduction is allowed for

any debt which becomes worthless within the taxable year. When

satisfied that a business debt is recoverable only in part, the

Commissioner may allow such debt, as a deduction, in an amount

not in excess of the part charged off within the taxable year.

See sec. 166(a)(2). As shown above, the notes were not wholly

worthless because some of the notes were later paid in full and

partial payments were made on others. Sec. 1.166-3(a)(2)(i),

Income Tax Regs., provides generally that if the District

Director is satisfied that a debt is partially worthless, the

amount which has become worthless will be allowed as a deduction

under sec. 166(a)(2), "but only to the extent charged off during

the taxable year." No portion of the notes owing to IRA was

charged off during the taxable year on its books and records.

The deduction for partial worthlessness is at the discretion of

the Commissioner and should not be interfered with by the Courts

unless the Commissioner was plainly arbitrary and unreasonable.

See Strahan v. Commissioner, 42 F.2d 729, 731 (6th Cir. 1930).
 - 556 -

IRA failed to establish that the Commissioner's failure to allow

deductions for the partial worthlessness of the debts described

was arbitrary or unreasonable. Accordingly, we hold that IRA is

not entitled to any bad debt deduction on the notes receivable

discussed.

Issue 26. Whether IRA Is Entitled to Claimed Bad Debt Deductions
for 1987

FINDINGS OF FACT

On its Federal income tax return for 1987, IRA claimed bad

debt deductions based on the worthlessness of the following notes

receivable:

Debtor Deduction

Claude Ballard $84,889
Robert Lisle 12,185
H. Abernathy 28,939
Forest Activities 6,000
Total 132,013

In the notice of deficiency, respondent disallowed IRA's

claimed bad debt deductions on the ground that it was not

established that any bad debts existed in fact and in law or, if

existing, were not adequately substantiated as to amount.

The transactions with Ballard and Lisle that gave rise to

the notes in question that were reflected on the books and

records of IRA were not loans but were amounts earned by Ballard

and Lisle for their respective roles in the Prudential income

scheme.
 - 557 -

IRA's writeoff of these notes receivable from Ballard and

Lisle was based on the contention that Ballard and Lisle did not

acknowledge that any debt existed.

During 1987 Ballard and Lisle had the resources to pay in

full the subject notes held by IRA.

IRA failed to establish that the notes of Ballard and Lisle

were in fact debts of Ballard and Lisle. If, however, the notes

represented indebtedness, IRA failed to establish that the notes

of Ballard and Lisle, in the amounts of $84,889 and $12,185,

respectively, became worthless in 1987.

H. Abernathy (Abernathy) was a preferred shareholder of IFI.

During 1974 and 1975, IFI lent Abernathy amounts totaling

$105,000. The loans were evidenced by three demand notes, signed

by Abernathy, that recited an interest rate of 10 percent. In

1977, the loans were partially repaid by crediting Abernathy's

preferred stock dividends from IFI against the balance of the

loans. As of December 1987, IFI's books reflected a balance due

on the loans of $67,098.04. In December 1987, IFI transferred

this loan to IRA as part of its consideration for the

cancellation of IFI's debt to IRA. IRA reduced the basis of this

loan to $28,862.29 and wrote off that amount as a bad debt.

IRA failed to establish that the note receivable from

Abernathy had any value prior to 1987 and failed to establish

that the note became worthless during 1987.
 - 558 -

Forest Activities, Ltd. (Forest), was a limited partnership,

previously known as Sherwood Associates. Alpha Financial Corp.

(AFC) was the sole general partner of Forest. Gallenberger was

the secretary of AFC. The record does not show what

consideration or transaction gave rise to the indebtedness owing

by Forest to IRA.

Forest owned rental property. According to the 1988

partnership return of Forest, its rental property was sold in a

foreclosure on March 31, 1988. According to the January 1, 1988,

balance sheet on Forest's 1988 return, Forest had assets with a

book value of $2,652,193 including $76,106 cash and liabilities

of $4,211,337 on that date.

After the foreclosure, as of December 31, 1988, Forest owned

cash of $17,121 and had no liabilities. In 1989, Forest earned

$20,055 income and, as of December 31, 1989, had cash of $37,176

and no liabilities. No evidence was presented as to the

financial worth of AFC, the general partner.

IRA failed to establish that the note receivable from Forest

in the amount of $6,000 existed in fact and failed to establish

that the note receivable became worthless during 1987.

OPINION

Section 166(a) allows a deduction for any debt that becomes

wholly worthless within the taxable year.
 - 559 -

To be entitled to a bad debt deduction under section 166,

the taxpayer, among other things, must establish that a genuine

debt in fact existed, and that the debt became worthless within

that taxable year. See Andrew v. Commissioner, 54 T.C. 239, 245

(1970); sec. 1.166-1(c), Income Tax Regs.

In deciding whether a debt has become worthless, we consider

whether a creditor in the exercise of sound business judgment

would conclude that the debt is uncollectible. See Andrew v.

Commissioner, supra at 248. Thus, whether a debt has become

worthless in a particular year is a question of fact. However,

the resolution of such issue is based on objective factors and

not merely on the taxpayer's subjective judgment as to

worthlessness. See generally sec. 1.166-2(a), Income Tax Regs.

IRA again argues that certain statements made by

respondent's counsel at trial were "concessions", and that the

only issue to be decided was whether the debts were worthless in

1987 when they were written off. Respondent, on the other hand,

contends that IRA failed to establish that (1) Ballard's and

Lisle's debts became worthless during 1987; (2) the Abernathy

debt (a) had any value prior to 1987, and (b) became worthless

during 1987; and (3) the Forest limited partnership debt (a)

existed in fact, and (b) became worthless during 1987.

We agree with respondent. First, we reject IRA's concession

argument. It has no merit.
 - 560 -

Second, we hold that IRA is not entitled to bad debt

deductions for the $84,889 and $12,185 writeoffs of the Ballard

and Lisle notes. Between 1982 and 1987, IRA or IFI paid Ballard

and Lisle $196,648 and $28,284, respectively, and reflected the

payments as notes receivables in those amounts from Ballard and

Lisle. IRA did not pay the funds to Ballard and Lisle as loans,

but rather as part of the moneys earned by Ballard and Lisle for

their role in the Prudential income scheme. In addition, the

record contains no notes or other written documentation of an

acknowledgment by Ballard or Lisle of purported debts to IRA and

IFI. There is no evidence that IRA charged any interest to

Ballard or Lisle, collected any interest from them, or demanded

any collateral with respect to the purported loans. Both Ballard

and Lisle disputed that their alleged debts to IRA existed. In

1987, when IRA wrote off the purported notes, neither Ballard nor

Lisle reported the discharge of this indebtedness as income on

their respective 1987 income tax return or subsequent returns.

Therefore, IRA failed to establish that any valid debt from

Ballard or Lisle existed that could be written off in 1987. But

even if valid debts existed, the evidence shows that both Ballard

and Lisle had sufficient resources in 1987 to pay in full to IRA

the alleged notes receivable. Consequently, IRA failed to

establish that the alleged notes receivable became worthless in

1987.
 - 561 -

IRA also failed to show that the $28,939 note receivable

from Abernathy became worthless in 1987. Similarly, with respect

to the Forest limited partnership note, IRA did not establish

that (1) a bona fide debt, in fact, existed, and (2) that the

debt became worthless in 1987.

Issue 27. Whether IRA Is Entitled to Claimed Ordinary Losses on
Sales of Notes Receivable for 1987

FINDINGS OF FACT

On its Federal income tax return for 1987, IRA claimed total

ordinary losses of $1,176,670 on purported sales to MAF, Inc.

(MAF), of business notes receivable from the following entities:

Note Receivable Maker Claimed Loss

HELO $485,824
Safari 42,494
CMB Cinema Trust 30,512
CMB Cinema Trust II 7,209
RWL Cinema Trust 9,290
RWL Cinema Trust II 29,294
HGA Cinema Trust 57,725
Elk Investment 33,000
Inter-Alia Investment 53,968
Steve and Karen Hargen 3,452
HELO 78,034
Cedilla Invest. 345,868
Total 1,176,670

In the notice of deficiency, respondent disallowed the above

losses on the grounds that IRA did not establish its basis in the

assets sold or disposed of, it did not demonstrate that the

transactions had any substance, and the sales were to a related
 - 562 -

party and were subject to section 267, which disallows losses

between related parties.

Pursuant to Kanter's instructions, in late December 1987,

IRA purportedly sold the notes receivable to MAF for $1 each in

an attempt to establish worthlessness for the sole purpose of

claiming a loss for Federal income tax purposes. The notes

receivable had been recorded on the books and records of IRA but

were not evidenced by any written notes and were not secured by

any collateral.

During 1987, Morrison was the president of MAF, which was

located in Florida. Morrison had known Kanter since the early

1960's. He and Kanter were friends and had mutual clients.

Morrison became president of MAF at the request of, and as a

favor to, Freeman. Morrison received no compensation for his

services as president of MAF. His secretary, Sue Hutton, was

secretary of MAF.

During 1987, MAF purportedly purchased the notes receivable

from IRA for $1 each as an accommodation to Kanter. The

collectibility of the notes did not matter to MAF or Morrison.

At the time MAF purportedly purchased the notes from IRA, MAF

knew nothing about the financial condition of the alleged makers

of the notes.

MAF held some small investments. It ceased doing business

in the late 1980's. The last transaction engaged in by MAF was
 - 563 -

its purported purchase of the notes from IRA. MAF never held

director or shareholder meetings.

During the years 1979 through 1989, Cedilla Invest. was a

subsidiary of IRA. Cedilla Invest. had total assets of

$10,008,632, $526,374, $526,374, and $575,896 on December 31,

1986, December 31, 1987, December 31, 1988, and December 31,

1989, respectively. Cedilla Invest. earned total income in the

amounts of $443,762, $52,656, and $11,702 for 1987, 1988, and

1989, respectively.

During 1983 and 1984, HELO was a subsidiary of Holding Co.

The proceeds of the "loans" to the Safari trust, CMB Cinema

Trust, CMB Cinema II Trust, RWL Trust, RWL Trust II, Elk

Investment, and Inter Alia Investment were used to invest in

unsuccessful film projects.

Ballard reported $41,697, $41,697, and $80 of income from

the CMB Cinema Trust II on his 1987, 1988, and 1989 returns,

respectively. Lisle reported $30 and $41,577 of income from the

RWL Cinema Trust II on his 1987 and 1988 returns. Ballard and

Lisle were, respectively, grantors of these trusts. See sec.

671.

With respect to the purported sales of notes receivable to

MAF in 1987, IRA failed to establish that it had any basis in the

notes.
 - 564 -

With respect to the purported sales of notes receivable to

MAF in 1987, IRA failed to establish that the sales of the notes

were in substance bona fide sales that gave rise to bona fide

losses.

IRA failed to establish that any of these notes became

wholly or partially worthless in 1987.

OPINION

IRA again makes the same arguments that were made with

respect to Issue 21; namely, that (1) certain statements by

respondent's counsel at trial are "concessions"; (2) IRA

substantiated its basis and is entitled to the ordinary losses

claimed; and (3) alternatively, if the Court holds either that

(a) the transactions were not bona fide transactions for tax

purposes, or (b) no loss is allowable under section 267 because

the sales were to a related party, IRA is still entitled to

deductions for partial worthlessness under section 166(a)(2).

Respondent, on the other hand, contends that IRA failed to meet

its burden of proof on this issue.

We agree with respondent for several reasons. The facts

pertaining to the sales of these notes parallel the facts

considered in Issue 21, wherein Kanter individually sold notes,
 - 565 -

bonds, and other security interests to MAF for nominal

consideration.62

On December 17, 1987, IRA acquired notes receivable totaling

$1,120,889 from IFI in cancellation of IFI's $507,648 note due to

IRA. This transfer included the notes receivable listed above

except those due from HELO and Cedilla Invest. in the amounts of

$485,824 and $345,868, respectively. (This is the same

transaction in which IRA acquired the Ballard, Lisle, and

Abernathy notes previously discussed.) While the principal

amounts of the notes acquired from IFI were greater than the

amounts set forth above, through an adjusting journal entry IRA

reduced the basis of these notes. On December 30, 1987, IRA sold

the notes for $1 each to MAF in an attempt to establish

worthlessness. Kanter testified that IRA knew that the notes

were worthless at the time IRA acquired the notes from IFI. The

transaction was entered into by IRA and IFI as a means to shift

62
Kanter assisted the CMB and RWL Trusts in obtaining these
loans from IRA and IFI to permit the trusts to invest in various
movie partnerships. The loans to the trusts essentially amounted
to nonrecourse loans to Ballard and Lisle, as Ballard and Lisle
had no legal obligation to repay the loans. However, because the
trusts were grantor trusts, Ballard and Lisle claimed the tax
benefits from the trusts' movie partnership investments on their
respective individual income tax returns. During the year at
issue, Cedilla Invest. was a subsidiary of IRA and is the same
entity that was involved in the equipment leasing transactions
considered in Issue 22. During 1983 and 1984, HELO was a
subsidiary of Holding Co. Elk Investment and Inter Alia
Investment had likewise borrowed funds to invest in unsuccessful
movie partnerships.
 - 566 -

artificially losses from IFI to IRA by mere bookkeeping entries.

As further discussed below, if the notes were worthless at the

time they were acquired by IRA, IRA could not have suffered a

loss by selling the notes because it did not part with anything

of value.

The CMB Cinema Trust and CMB Cinema Trust II were trusts for

the benefit of Ballard's family and the RWL Cinema Trust and RWL

Cinema Trust II were trusts for the benefit of Lisle's family.

IRA and/or IFI did not pay or transfer moneys to the CMB Cinema

Trust, CMB Cinema Trust II, RWL Cinema Trust and RWL Cinema Trust

II as loans but rather as part of the moneys earned by Ballard

and Lisle for their roles in the Prudential income scheme and,

therefore, the funds were not intended to be repaid. The alleged

notes receivable or debts did not in fact exist, and IRA did not

establish its basis in the alleged notes receivable.

With respect to the claimed losses on the sales of the other

alleged notes receivable, IRA presented no evidence that IRA, as

opposed to Administration Co., paid or advanced moneys as loans

to the alleged debtors. IRA presented no evidence as to why the

funds were advanced to the alleged debtors. Except for a

notation as to the interest rate for some of the alleged loans

listed in its Loans Receivable ledger, IRA presented no evidence

regarding the terms of the alleged loans such as the due dates or

interest rates. IRA presented no evidence that the loans were
 - 567 -

secured by any collateral, nor was there any evidence of payments

on the loans. Although these loans were listed on IRA's books

and records as "Notes Receivable" or "N/R", no notes or any other

written acknowledgment of the alleged loans was introduced into

evidence. With the exception of Kanter, in his capacity as

trustee of the HGA Cinema Trust, none of the alleged debtors

testified as to the existence of any debt. In our view, IRA's

lack of notes or other written acknowledgment of the existence of

these debts, lack of any collateral, and lack of repayments

indicate that, like the payments to the Ballard and Lisle family

trusts, IRA never intended that the alleged debtors would be

required to repay these funds. Consequently, the alleged loans

did not exist. In sum, we conclude that IRA failed to establish

that the claimed notes receivable represented valid debts

stemming from debtor-creditor relationships and, therefore,

failed to show that it had any basis from which any loss could be

determined on their purported sales.

Economically, the sales of the notes receivable of

$1,760,682 for $12 make no sense. If the notes were not

worthless, IRA would not have sold them for $12. If the notes

were worthless, an unrelated third party would not have had any

interest in purchasing them for $12.

Kanter testified that he and Freeman agreed that the notes

receivable in question were worthless. Kanter explained that the
 - 568 -

purpose of the "sales" to MAF was to establish "worthlessness".

Kanter's testimony was corroborated by Morrison, who stated that

MAF bought the notes from IRA as an "accommodation" to Kanter.

Morrison further testified that, at the time MAF "purchased" the

notes, Morrison did not know the financial condition of the

alleged makers of the notes and that it did not matter to him

whether or not the notes were collectible. Like the previously

discussed 1985 "sales" of notes receivable by IRA to Kanter and

Holding Co., the testimony of Kanter and Morrison, and the lack

of economic substance to the "sales" show that the sole purpose

of the "sales" was to establish a basis for IRA to claim losses

for Federal income tax purposes.

Although IRA did not deduct the alleged notes receivable as

bad debts, Kanter testified that he believed that the notes were

worthless. However, IRA did not establish that any of the

claimed notes became worthless in 1987, and, therefore, IRA is

not entitled to a bad debt deduction for 1987 for such notes.

With respect to the notes acquired from IFI, in order to

prove entitlement to a bad debt deduction in the amounts claimed,

IRA must show that the notes had their face values at the time

acquired by IRA on December 22, 1987, and that an event occurred

to cause them to become worthless by December 31, 1987. See

Dustin v. Commissioner, 53 T.C. 491, 501 (1969), affd. 467 F.2d

47 (9th Cir. 1972). IRA failed to do so.
 - 569 -

With respect to the HELO notes, Kanter testified that "It

was an entity that had ceased doing business sometime earlier. I

don't know exactly when. It had no assets." This statement that

HELO had no assets lacks foundation in his personal knowledge of

the financial condition of HELO, and we disregard it. In any

event, even if Kanter's testimony is to be believed, his

testimony does not establish the year that the alleged HELO debts

actually became worthless.

With respect to the Safari, Elk Investment, and Inter Alia

notes, Kanter's statements that these entities had no assets also

lack in foundation in his knowledge of the financial condition of

these entities and, therefore, are disregarded. In any event,

even if Kanter's testimony is to be believed, his testimony does

not establish the year that these alleged debts actually became

worthless.

With respect to the CMB Cinema Trust, CMB Trust II, RWL

Cinema Trust, and RWL Cinema Trust II "notes", these "loans" were

fictitious and used as a means to transfer funds to Ballard and

Lisle. Therefore, IRA is not entitled to a loss on the sale of

these "notes."

With respect to the alleged note receivable from Steve and

Karen Hargen, Kanter testified that because neither he nor anyone

he knew could locate Steve Hargen, "it was considered worthless".

No other evidence was presented of any efforts to locate the
 - 570 -

Hargens or to collect on the note, nor was any persuasive

evidence presented to show that this note became worthless in

1987.

With respect to the note receivable from Cedilla Invest.,

Kanter testified that "It had no assets, as best I recall, that

could be assessed effectively to recoup this note". This

statement is not sufficient evidence to establish that the

alleged note became worthless in 1987. It lacks any foundation

in Kanter's personal knowledge of Cedilla Invest.'s assets. In

addition, the balance sheets of Cedilla Invest. included in IRA's

1986 to 1989 tax returns show that Cedilla Invest. had total

assets of $10,008,632, $526,374, $526,374, and $575,896 at

December 31, 1986, 1987, 1988, and 1989, respectively. IRA

presented no evidence that the fair market value of these assets

was less than the liabilities of Cedilla Invest. IRA's returns

also show that Cedilla Invest. earned total income in the amounts

of $443,762, $52,656, and $11,702 for 1987, 1988, and 1989,

respectively. These returns indicate that Cedilla Invest. had

assets with which to pay the alleged note receivable, that

Cedilla Invest. continued to be a going concern after 1987, and,

therefore, that the Cedilla Invest. note had current liquidating

value or potential value.
 - 571 -

In summary, we hold that IRA is not entitled to bad debt

deductions for partial worthlessness of the notes receivable in

1987.

Issue 28. Whether IRA Is Entitled to Certain Capital Losses for
1987

FINDINGS OF FACT

On its Federal income tax return for 1987, IRA reported

capital losses as follows:

Gross
Date Date Sale
Description Acquired Sold Price Basis Loss

Int'l Films (IFI) 8/2/76 1987 -- $65,000 ($65,000)
Brickell Biscayne 1983 12/22/87 $1,000 176,073 (175,073)
Sandberg Village 1979 12/22/87 1,000 492,691 (491,691)
1984 Devel. Ltd. 1982 12/22/87 1,000 23,862 (22,862)

Total 3,000 757,626 (754,626)

In the notice of deficiency, respondent disallowed the

claimed capital losses on the grounds that IRA did not establish

its basis in the assets sold or disposed of, IRA did not

demonstrate that the transactions had any substance, and the

sales were to a related party and were subject to section 267,

which disallows losses between related parties.

IRA's records reflect that it sold its 1,500 shares of IFI

stock to Gallenberger for $1 on September 28, 1988. An entry

recording the September 1988 sale to Gallenberger was made on

IRA's 1988 ledger. Subsequently, adjusting journal entries were

made to IRA's books and records to reverse the 1988 entry as a

sale of the stock and to reflect on IRA's books a writeoff of the
 - 572 -

stock as a worthless security in 1987. IRA failed to establish

that its stock in IFI became worthless in 1987.

Pursuant to Kanter's instructions, in late December 1987,

IRA purportedly sold the Brickell Biscayne, Sandberg Village, and

1984 Development, Ltd., partnership interests to MAF for $1,000

each solely in an attempt to establish worthlessness for the

purpose of claiming a loss for Federal income tax purposes.

MAF purchased these partnership interests from IRA as an

accommodation to Kanter.

At the time of IRA's sale of its interests in Brickell

Biscayne and Sandberg Village to MAF, Brickell Biscayne and

Sandberg Village were not dissolved and were still engaged in

their operations.

With respect to these purported sales of partnership

interests, IRA failed to establish that it had any basis in the

partnerships. It also failed to establish that the sales of

these interests were in substance bona fide sales.

IRA failed to establish that its partnership interests in

Brickell Biscayne, Sandberg Village, and 1984 Development Ltd.

became worthless in 1987.

OPINION

Pursuant to section 165(g), an exception is created to the

general requirement of realization through sale or exchange for

losses on certain securities. If a security which is a capital
 - 573 -

asset becomes worthless during the taxable year, the resulting

loss is treated as a loss from the sale or exchange of the

capital asset on the last day of that year even though a sale or

exchange has not actually taken place. Under section 165(g)(2),

the term "security" is defined as:

(A) a share of stock in a corporation;

(B) a right to subscribe for, or to receive, a share of
stock in a corporation; or

(C) a bond, debenture, note, or certificate, or other
evidence of indebtedness, issued by a corporation or by
a government or political subdivision thereof, with
interest coupons or in registered form.

To be entitled to a deduction under section 165(g), the

taxpayer has the burden of showing that (1) the stock had a

basis; (2) the stock was not worthless prior to the year in which

worthlessness is claimed; and (3) the stock became worthless in

the year claimed.

Contrary to IRA's assertion, the record does not establish

that the IFI shares became wholly worthless during 1987. IRA's

1988 ledger shows that the IFI shares were sold by it to

Gallenberger for $1 in 1988. Although Gallenberger, in her

testimony, could not recall details about this purchase, she did

acknowledge purchasing the shares for $1 from IRA on September

28, 1988. IRA offered no explanation for the apparent

inconsistency in first recording on its books a sale of the stock

during 1988 and then later reversing such entry on its records
 - 574 -

and instead claiming that the stock became wholly worthless in

the preceding year, 1987. Moreover, no evidence was presented to

establish IRA's basis in the IFI stock. Consequently, we

conclude that IRA failed to meet its burden of establishing

entitlement to a worthless security deduction under section

165(g) on the IFI stock. Thus, we sustain respondent's

determination that no capital loss is allowable to IRA for 1987

with respect to the IFI stock.

With respect to the claimed capital losses on the sale of

the three partnership interests to MAF, the Court again rejects

IRA's "concession" argument that certain statements of

respondent's counsel constituted an abandonment or waiver of the

grounds in the notice of deficiency for disallowance of these

losses. We also conclude that IRA failed to establish the

amounts claimed as bases and that the purported sales to MAF of

the partnership interests were bona fide transactions.

Therefore, we sustain respondent's determination.

Issue 29. Whether IRA Is Entitled To Deduct as Business Expenses
Amounts Paid to J.D. Weaver in 1979, 1981, and 1982

OPINION

In the notice of deficiency issued to IRA for 1983

respondent disallowed "commission expenses" in the amount of

$108,753. The claimed expenses are for payments made by IRA's

subsidiary KWJ Corporation to J.D. Weaver. Although respondent

acknowledges that the 1983 adjustment was erroneously conceded,
 - 575 -

respondent on brief stands by the concession for that year.

However, respondent filed Amendments to Answers in IRA's cases

for 1979, 1981 and 1982. In such Amendments to the Answers,

respondent claimed that the "commission expenses" paid to J.D.

Weaver in 1979, 1981, and 1982 in the amounts of $51,643,

$38,601, and $74,015, respectively, should be disallowed.

Contrary to IRA's contention, respondent's concession for

1983 does not mean a concession by respondent that the payments

to Weaver by IRA's subsidiary KWJ were "commissions" for work or

services Weaver performed for either IRA or KWJ in 1979, 1981 and

1982. It is clear that in the Hyatt transactions, Weaver

influenced Lisle in connection with the awarding of the

Embarcadero management contract to Hyatt. For his influence,

A.N. Pritzker gave Weaver a 10-percent interest in the profits

that Hyatt earned on the hotel. These payments were made by

Hyatt to KWJ. After Hyatt went private, Weaver sold his stock in

KWJ Corporation to IRA. In the sale, Weaver retained the right

to receive 30 percent of the commissions thereafter paid by

Hyatt. As these commissions were later paid by Hyatt to KWJ, the

30-percent portion was remitted to Weaver by IRA pursuant to the

sales agreement. These amounts were claimed as business expense

deductions on the consolidated income tax returns of IRA (which

included KWJ's operations) for the years in question. The Court

is satisfied from the record that after the sale of the KWJ stock
 - 576 -

to IRA, Weaver did not perform any services for IRA or KWJ and

the payment of the 30-percent amounts to Weaver did not

constitute compensation for services rendered. The amounts thus

paid are not deductible by KWJ and/or IRA. The full amounts paid

by Hyatt to KWJ constitute gross income to IRA. However, the

Court is satisfied that the 30-percent payments by IRA to Weaver

represented part of the purchase price by IRA for the KWJ stock

and, to that extent, the payments to Weaver would add to and

increase IRA's basis in the stock of KWJ Corporation. Therefore,

respondent is sustained on this issue.

Issue 30. Whether the Assessment and Collection of the
Deficiency and Additions to Tax as to IRA for 1980 Are Barred by
the Statute of Limitations

FINDINGS OF FACT

IRA's 1980 Federal income tax return was due to be filed on

March 15, 1981. Pursuant to two requests for extensions of time

for filing, which were granted, the due date for IRA's 1980

return was extended to September 15, 1981. However, IRA did not

file its return on or before the extended date. IRA filed its

1980 return by mail in an envelope bearing a U.S. Postal Service

postmark of November 20, 1981, properly addressed to the Internal

Revenue Service. The letter was sent by ordinary mail and was

neither certified nor registered. The return was received by the

IRS Kansas City Service Center and was date stamped November 24,

1981. There is an additional date stamp on the return indicating
 - 577 -

a filing date of November 21, 1981. The differing dates are not

material for purposes of this issue.

On November 20, 1984, IRA and respondent executed a written

agreement on Form 872-A, Special Consent to Extend the Time to

Assess Tax, to extend the period of limitations on respondent's

assessment and collection of IRA's income taxes for 1980. This

Form 872-A has generally been referred to as an "open-ended"

consent because it extends the period of limitations indefinitely

until either the taxpayer or the IRS issues to the other a Form

872-T to effect a termination of the extension. If the taxpayer

issues the Form 872-T, the extension continues for a period of 90

days, within which the IRS must issue a notice of deficiency to

the taxpayer. Neither IRA nor the IRS issued a Form 872-T. On

June 2, 1992, respondent issued the notice of deficiency to IRA

for its 1980 tax year.

In its petition, IRA affirmatively alleged that the period

of limitations barred respondent's assessment and collection of a

deficiency and additions to tax against it for 1980.

In the answer, respondent affirmatively alleged that the

applicable period of limitations on assessment and collection

against IRA for 1980 had not expired at the time the notice of

deficiency was issued because respondent and IRA had executed a

written agreement extending the period of limitations

indefinitely until the onset of one of the conditions stated
 - 578 -

above, and that, because neither party had terminated the

consent, the notice of deficiency was timely issued.

OPINION

Section 6501(a) generally requires that a deficiency in

income tax be assessed within 3 years after a return is filed.

However, under section 6501(c)(4), the parties may extend by

agreement the 3-year period of limitations for assessment,

"Where, before the expiration of the time prescribed * * * for

the assessment * * * both the Secretary and the taxpayer have

consented in writing to its assessment after such time".

IRA contends that the period of limitations under section

6501 expired prior to the time the notice of deficiency for 1980

was issued. It maintains that the period of limitations had

expired on November 20, 1984, that the Form 872-A extending the

period of limitations was executed after the period of

limitations had run, and, therefore, the Form 872-A was of no

effect. Respondent contends otherwise.

We agree with respondent. The question is whether, under

section 6501(c)(4), the parties extended the agreement "before

the time prescribed (for assessment)" had expired.

The tax return for 1980, which was due on September 15,

1981, was mailed by ordinary mail, bearing a U.S. Postal Service

postmark of November 20, 1981. The return was received by the

IRS on either November 21 or November 24, 1981. The IRS Form
 - 579 -

872-A, to extend the period of limitations, is dated November 20,

1984.

Where a return is mailed and bears a U.S. Postal Service

postmark on or before the due date but is received by the IRS

after the due date, the return is timely filed. See sec.

7502(a); Miller v. United States, 784 F.2d 728, 730 (6th Cir.

1986). However, if the return is mailed after the due date, the

return is considered filed on the date the return is actually

received by the IRS. See Radding v. Commissioner, T.C. Memo.

1988-250. IRA's return was not mailed before the due date of the

return. It was mailed more than 1 month late. The return was

received on either November 21 or November 24, 1981. Therefore,

the return is deemed to have been filed on November 21 or

November 24, 1981. The Form 872-A was signed by the parties on

November 20, 1984. Therefore, "before the expiration of the time

prescribed * * * for the assessment", the parties agreed to an

extension of the period of limitations. Thus the notice of

deficiency was timely issued.

Accordingly, we hold that the statute of limitations does

not bar the assessment and collection of the deficiency in income

tax and additions to tax due from IRA for 1980.
 - 580 -

Issue 31. Whether IRA Is Liable for the Fraud Addition to Tax
for 1987

OPINION

In an amended answer, respondent alleged that IRA was liable

for the addition to tax for fraud under section 6653(b) for 1987,

based on improper deductions claimed by IRA for certain bad debts

and capital losses. Although the Court has sustained

respondent's disallowance of these claimed deductions and losses,

it has done so, in some instances, because of IRA's failure to

establish that (1) the purported sales of many of the assets were

bona fide transactions, and (2) the purported buyer was not a

related party under section 267. Nevertheless, insofar as IRA's

liability for an addition to tax under section 6653(b) for 1987

is concerned, respondent bears the burden of proving, by clear

and convincing evidence, that some part of the underpayment for

that year resulting from these disallowed deductions and losses

was due to fraud. See sec. 7454(a); Rule 142(b).

Although IRA addressed this issue in its briefs, respondent

failed to do so. We therefore conclude that respondent abandoned

the fraud issue as to IRA for 1987. Accordingly, we hold that

IRA is not liable for the addition to tax for fraud under section

6653(b) for that year.
 - 581 -

Issue 32. Whether Assessment and Collection of Federal Income
Taxes of Kanter, Ballard, and Lisle Are Barred by the Statute of
Limitations for Some Years

OPINION

Petitioners contend that the assessment of tax for the

Ballards' 1978, 1979, 1981, 1982, and 1984 years, the Lisles'

1984 year, and the Kanters' 1983 year is barred by the statute of

limitations under section 6501(a).

Section 6501(c)(1) provides that the tax may be assessed "at

any time" in the case of a false or fraudulent return with the

intent to evade tax. The definition of fraud for purposes of

additions to tax under section 6653(b) also applies for purposes

of determining the application of section 6501(c)(1). See

Schaffer v. Commissioner, 779 F.2d 849, 857 (2d Cir. 1985), affg.

Mandina v. Commissioner, T.C. Memo. 1982-34; Ruidoso Racing

Association v. Commissioner, 476 F.2d 502, 505 (10th Cir. 1973),

affg. T.C. Memo. 1971-194; Tomlinson v. Lefkowitz, 334 F.2d 262

(5th Cir. 1964); Estate of Temple v. Commissioner, 67 T.C. 143,

159-160 (1976); McGee v. Commissioner, 61 T.C. 249, 252, 261

(1973), affd. 519 F.2d 1121 (5th Cir. 1975).

Having found and held that part of the underpayment of tax

was due to fraud with intent to evade tax (1) as to Kanter for

the years 1978 through 1984 and 1986 through 1989, (2) as to

Ballard for 1978 through 1982, 1984, and 1987 through 1989, and

(3) as to Lisle for 1984 and 1987 through 1989, it follows that
 - 582 -

the assessment and collection of their Federal income taxes for

such years are not barred by the statute of limitations. See

sec. 6501(c)(2).

Issue 33. The Liabilities of Kanter, Ballard, and Lisle for
Additions to Tax for Negligence

OPINION

The Court has held that Kanter is liable for fraud additions

to tax for the years 1978 through 1984 and for the years 1986

through 1989. The Court has also held that Ballard is liable for

the fraud addition to tax for the years 1975 through 1982, for

the year 1984, and for the years 1987 through 1989. The Court

has further held that Lisle is liable for the fraud addition to

tax for the year 1984 and the years 1987 through 1989.

In the notices of deficiency and/or in amended pleadings,

respondent also determined and/or asserted the additions to tax

for negligence or intentional disregard of rules or regulations

against Kanter under section 6653(a) with respect to activities

other than the Prudential activities as to which the Court has

concluded that the fraud addition to tax is applicable.63

Respondent agrees on brief that for years prior to 1986, if

the addition to tax for fraud is applicable, the amount of the

fraud addition to tax is calculated on the entire underpayment of

tax, including underpayments relating to nonfraudulent

63
See supra note 3 outlining the various versions of section
6653(a) in effect during the years at issue.
 - 583 -

activities, and the addition to tax for negligence or intentional

disregard of rules or regulations does not apply to underpayments

attributable to nonfraudulent activities. Therefore, respondent

agrees that for all tax years prior to 1986, even though the

negligence addition to tax was determined or asserted with

respect to nonfraudulent activities, the negligence addition to

tax is not applicable if fraud is held applicable for the years

prior to 1986. For tax years after 1985, the addition to tax for

fraud applies only to the underpayment in tax attributable to

fraud; therefore, a taxpayer may be held liable for the

negligence addition to tax on underpayments attributable to

nonfraudulent activities. Thus, with respect to Kanter, the

Court holds that the negligence addition to tax is not applicable

to Kanter's 1978 through 1984 tax years since the Court has held

that Kanter is liable for fraud for those years. The Court,

therefore, considers the negligence addition to tax relating to

nonfraudulent activities for Kanter's 1986 through 1989 tax

years. With respect to Ballard and Lisle, the parties agree that

the additions to tax asserted against them related only to the

Prudential issue. Since the Court has held that Ballard and

Lisle are subject to the fraud addition to tax with respect to

the Prudential activity, there are no additions to tax for

negligence as to Ballard and Lisle which are to be considered by

the Court.
 - 584 -

Generally, if any part of a taxpayer's underpayment of

income tax for a taxable year is attributable to negligence or

intentional disregard of rules or regulations, section 6653(a)

imposes an addition to tax equal to 5 percent of the

underpayment. For returns the due date for which (determined

without regard to extensions) is after December 31, 1986, section

6653(a)(1)(B) imposes an addition to tax equal to 50 percent of

the statutory interest with respect to the portion of the

underpayment attributable to negligence or intentional disregard

of rules and regulations. See Tax Reform Act of 1986, Pub. L.

99-514, sec. 1503(a), 100 Stat. 2742. This addition to tax,

equal to 50 percent of the statutory interest, was repealed by

sec. 1015(b)(2)(a) of the Technical and Miscellaneous Reverse Act

of 1988, Pub. L. 100-647, 102 Stat. 3569, effective for returns

the due date for which (determined without regard to extensions)

is after December 31, 1988.

Negligence is the failure to exercise due care or the

failure to do what a reasonable or ordinarily prudent person

would do under the circumstances. See Zmuda v. Commissioner, 731

F.2d 1417, 1422 (9th Cir. 1984), affg. 79 T.C. 714 (1982); Neely

v. Commissioner, 85 T.C. 934, 937 (1985).

Kanter contends that no additions to tax under section

6653(a) should be imposed against him because he acted

reasonably. Alternatively, he argues that, to the extent he
 - 585 -

"inadvertently" failed to address some adjustments, this omission

on his part was caused by respondent's representing "at the

conclusion of the trial that all issues upon which petitioners

bore the burden of proof had been addressed by petitioners

(subject to certain specifically identified exceptions)."

Respondent, on the other hand, contends that Kanter is

liable for additions to tax under section 6653(a) because he, a

knowledgeable tax attorney, was negligent, and he failed to meet

his burden of proving that he acted reasonably or exercised due

care.

We agree with respondent. We first reject Kanter's

contention that he should somehow be "excused" from liability for

additions to tax under section 6653(a) with respect to those

adjustments he may have "inadvertently" failed to address because

of respondent's alleged statement near conclusion of the trial

that Kanter had "addressed all issues" upon which he had the

burden of proof. As previously discussed, we conclude that such

statement was not a waiver or concession by respondent of those

issues raised in the notices of deficiency. Furthermore, the

Court does not believe that Kanter was misled because the Court

twice advised his counsel that he was responsible for seeing that

Kanter had fully addressed all issues upon which Kanter bore the

burden of proof.
 - 586 -

Our findings and conclusions with respect to the following

issues clearly show that portions of Kanter's underpayments of

income taxes were attributable to negligence or intentional

disregard of rules or regulations to the extent the 1986 through

1989 tax years are involved: (1) Commitment fees received by

Century Industries (Issue 2); (2) income of the Bea Ritch Trusts

(Issue 4); (3) interest deduction for 1986 (Issue 17); and (4)

capital gains and losses (Issue 21). Also, Kanter conceded some

adjustments but failed to address the additions to tax for

negligence with respect thereto. Unlike the underpayments

attributable to fraud with respect to the "Prudential Issues" or

"The Five", only the negligence additions to tax apply to these

issues. See sec. 6653(a)(2); sec. 6653(b)(2).

Issue 34. Whether the Kanters Are Liable for the Section 6659
Addition to Tax for 1981

OPINION

This issue relates to the Kanters' liability for the

addition to tax under section 6659 for substantial valuation

overstatement with respect to a $4,283 loss claimed from GLS

Associates on their 1981 income tax return. We sustained

respondent's disallowance of this loss (Issue 13). On their 1981

return, the Kanters also claimed an investment interest expense

deduction relating to GLS Associates in the amount of $45,095,

which respondent disallowed in the notice of deficiency. In a

Stipulation of Settled Issues dated April 12, 1990, the Kanters
 - 587 -

conceded the $45,095 investment interest expense adjustment but

did not concede the additions to tax attributable thereto.

Respondent determined that the amount of the addition to tax

under section 6659 was 30 percent of the underpayment

attributable to these adjustments.

Section 6659 provides for an addition to tax for

underpayments attributable to valuation overstatements. A

valuation overstatement exists if, among other conditions, the

adjusted basis of property claimed on the return equals or

exceeds 150 percent of the correct amount of the basis. As to

the year at issue, for valuation overstatements of 150 percent or

more but not more than 200 percent, the addition to tax is 10

percent of the underpayment attributable to the valuation

overstatement; for valuation overstatements of more than 200

percent but less than 250 percent, the addition is 20 percent of

the underpayment attributable to the valuation overstatement; and

for valuation overstatements of 250 percent or more, the addition

is 30 percent of the underpayment attributable to the valuation

overstatement. No addition is imposed under section 6659 unless

the underpayment in tax attributable to the valuation

overstatement is at least $1,000.

The Kanters contend that they should not be held liable for

the addition to tax under section 6659, citing Heasley v.

Commissioner, 902 F.2d 380 (5th Cir. 1990), revg. T.C. Memo.
 - 588 -

1988-408. On brief, they maintain that "neither party introduced

any evidence" with respect to the GLS Associates' adjustment.

Respondent, on the other hand, contends that the Kanters

failed to establish that they are not liable for the addition to

tax under section 6659 with respect to the GLS Associates'

valuation overstatement.

The Kanters presented no evidence on this issue. They have

not shown that the underpayment was attributable to anything

other than a valuation overstatement.64 Consequently, we sustain

64
Sec. 6659 does not apply to underpayments of tax that are
not "attributable to" valuation overstatements. See McCrary v.
Commissioner, 92 T.C. 827 (1989); Todd v. Commissioner, 89 T.C.
912 (1987), affd. 862 F.2d 540 (5th Cir. 1988). To the extent
taxpayers claim tax benefits that are disallowed on grounds
separate and independent from valuation overstatements, the
resulting underpayments of tax are not regarded as attributable
to valuation overstatements. See Krause v. Commissioner, 99 T.C.
132, 178 (1992), affd. sub nom. Hildebrand v. Commissioner, 28
F.3d 1024 (10th Cir. 1994). However, when valuation is an
integral factor in disallowing deductions and credits, sec. 6659
is applicable. See Illes v. Commissioner, 982 F.2d 163, 167 (6th
Cir. 1992), affg. T.C. Memo. 1991-449; Gilman v. Commissioner,
933 F.2d 143, 151 (2d Cir. 1991), affg. T.C. Memo. 1989-684;
Masters v. Commissioner, T.C. Memo. 1994-197, affd. without
published opinion 70 F.3d 1262 (4th Cir. 1995). In Gainer v.
Commissioner, 893 F.2d 225 (9th Cir. 1990), affg. T.C. Memo.
1998-416; Todd v. Commissioner, supra; and McCrary v.
Commissioner, supra, it was found that a valuation overstatement
did not contribute to an underpayment of taxes. In Todd and
Gainer, the underpayments were due exclusively to the fact that
the property in each case had not been placed in service. In
McCrary, the underpayments were deemed to result from a
concession that the agreement at issue was a license and not a
lease. As this Court indicated in Becker v. Commissioner, T.C.
Memo. 1996-538, Heasley v. Commissioner, 902 F.2d 380 (5th Cir.
1990), revg. T.C. Memo. 1988-408, which petitioners herein cite,
may be interpreted to represent merely an application of Todd.
(continued...)
 - 589 -

respondent's determination and hold that the Kanters are liable

for the addition to tax under section 6659 equal to 30 percent of

the underpayment attributable to the GLS Associates adjustment.

Issue 35. Whether Kanter Is Liable for Section 6661 Additions to
Tax for 1982 Through 1984, and 1986 Through 1988

OPINION

Section 6661(a) provides that, if there is a substantial

understatement of income tax for any year, there will be added to

the tax an amount equal to 25 percent of the amount of any

underpayment attributable to such understatement. See Pallottini

v. Commissioner, 90 T.C. 498 (1988). For purposes of this

section, a substantial understatement exists if the amount of the

understatement for the taxable year exceeds the greater of 10

percent of the tax required to be shown on the return or $5,000.

See sec. 6661(b)(1).

The term “understatement” means the excess of the tax

required to be shown on the return over the amount of tax imposed

which is shown on the return. Sec. 6661(b)(2)(A). The amount of

the understatement is reduced by that portion of the

(...continued)
However, as the Court further noted in Becker, to the extent that
the Court of Appeals for the Fifth Circuit's reversal in Heasley
may be read as based on a concept that, where an underpayment
derives from a lack of economic substance, the underpayment
cannot be attributable to an overvaluation, this Court, the Court
of Appeals for the Second Circuit, and other Courts of Appeals
have disagreed with the Fifth Circuit. See Gilman v.
Commissioner, supra.
 - 590 -

understatement which is attributable to the tax treatment of any

item by the taxpayer if there is or was substantial authority for

such treatment or the relevant facts affecting the item's tax

treatment are adequately disclosed in the return or in a

statement attached thereto. See sec. 6661(b)(2)(B). With

respect to tax shelters, the understatement is reduced only if

the taxpayer establishes that he reasonably believed that the tax

treatment of such item by the taxpayer was more likely than not

the proper treatment. See sec. 6661(b)(2)(C)(i). The term "tax

shelter" includes a partnership or any other plan or arrangement

if the principal purpose of such partnership, entity, plan, or

arrangement is the avoidance or evasion of Federal income tax.

Sec. 6661(b)(2)(C)(ii).

In notices of deficiency for 1982 through 1984 and 1986

through 1988, respondent determined that the Kanters' entire

underpayment for each year was a substantial understatement

within the meaning of section 6661. Respondent's determination

is presumed correct. Kanter had the burden of proving that

respondent's determination was erroneous. He failed to do so.

In amendments to answers for 1982 through 1984 and 1986

through 1988, respondent asserted the section 6661 addition to

tax with respect to any underpayments of tax arising from

unreported income not included in the notices of deficiency.

Respondent had the burden of proof to the extent that the section
 - 591 -

6661 addition to tax had been asserted by amended pleadings. See

Rule 142(a).

As his Federal income tax returns show, Kanter did not

adequately disclose the relevant facts concerning the tax

treatment of the various items at issue in these cases. There is

and was no substantial authority for his tax treatment of such

issues. He had no reason to believe that his treatment of tax

shelter items was more likely than not the correct treatment. In

this regard, the assignment of income adjustments (Prudential,

Century Industries, Hi-Chicago Trust, CMS Investors), Bea Ritch

Trusts adjustments, Cashmere adjustments, Schedule E computer

leasing adjustments, and the adjustments disallowing losses on

sales of notes receivable and stock to Windy City and MAF for

nominal consideration are items attributable to tax shelters

because they involve entities and arrangements the principal

purpose of which was avoidance or evasion of Federal income tax.

See United States v. Dahlstrom, 713 F.2d 1423 (9th Cir. 1983).

The evidence affirmatively shows that Kanter did not have

substantial authority for failing to report the assigned income

at issue or substantial authority for his tax treatment of other

items at issue. Therefore, except as otherwise provided in

stipulations of settled or conceded issues, we sustain

respondent's determination that the entire underpayment of income

tax for each of the years 1982 through 1984 and 1986 through 1988
 - 592 -

constituted a substantial understatement of tax for which there

was no substantial authority or adequate disclosure within the

meaning of section 6661. The amounts of the additions to tax

under section 6661 can be determined in Rule 155 computations.

Issue 36. Whether Kanter Is Liable for Section 6621(c) Increased
Interest for 1978, 1979, 1980 Through 1984, and 1986, and 1987,
and 1988

OPINION

For the year at issue, section 6621(c), increased the

interest rate due on a deficiency to 120 percent of the statutory

rate (established under section 6601) on any underpayment of tax

that exceeds $1,000 attributable to "tax motivated transactions",

as defined in section 6621(c)(3). A tax-motivated transaction

includes, but is not limited to, a valuation overstatement (150

percent or more) under section 6659(c), any loss disallowed under

section 465(a), any credit disallowed under section 46(c)(8), any

sham transaction, and/or any fraudulent transaction. See sec.

6621(c)(3). Under section 6621(c)(3), tax-motivated transactions

also include transactions entered into without the requisite

profit motive and which lack economic substance. See Patin v.

Commissioner, 88 T.C. 1086 (1987), affd. without published

opinion 865 F.2d 1264 (5th Cir. 1989), affd. without published

opinion sub nom. Hatheway v. Commissioner, 856 F.2d 186 (4th Cir.

1988), affd. sub nom. Skeen v. Commissioner, 864 F.2d 93 (9th

Cir. 1989), affd. sub nom. Gomberg v. Commissioner, 868 F.2d 865
 - 593 -

(6th Cir. 1989). Under section 6621(c)(3), tax-motivated

transactions also include losses disallowed by reason of invalid

debt. See HGA Cinema Trust v. Commissioner, T.C. Memo. 1989-370.

In notices of deficiency for 1981, 1983, 1984, 1986, and

1987, respondent determined that the Kanters' entire underpayment

was a substantial underpayment attributable to tax-motivated

transactions within the meaning of section 6621(c). Respondent's

determination is presumed correct, and Kanter had the burden of

proving that the determinations were erroneous.

In the answer to docket No. 1350-87 involving 1982,

respondent affirmatively alleged that the entire underpayment was

a substantial underpayment attributable to tax-motivated

transactions under section 6621(c). In amendments to answers for

1978 through 1984, and 1986 and 1988, respondent affirmatively

alleged that the increased underpayments resulting from Kanter's

failure to report "kickback" income were attributable to tax-

motivated transactions within the meaning of section 6621(c). To

the extent that the applicability of the increased interest rate

of section 6621(c) has been raised by answer or amendments to

answers, respondent bears the burden of proof. See Rule 142(a).

This Court has held that an underpayment attributable to the

taxpayer's failure to report income that was assigned to a

fraudulent or sham trust is an underpayment attributable to tax-

motivated transactions. See Kerr v. Commissioner, T.C. Memo.
 - 594 -

1987-470. Respondent contends that IRA and its subsidiaries,

Holding Co. and its subsidiaries, Century Industries, Oyster Bay

Associates, the Delta Partnership, the Alpha Partnership, CMS

Investors and the Bea Ritch Trusts were fraudulent or sham

entities within the meaning of section 6621(c)(3). Therefore,

respondent argues that any underpayments arising from Kanter's

failure to report his income that he assigned to these entities

or that was otherwise reportable as his income even though

reported as income by these entities are attributable to tax-

motivated transactions within the meaning of section 6621(c).

More specifically, respondent argues that underpayments relating

to Kanter's failure to report kickback income as set forth in the

notices of deficiency and amended answers, consulting income

assigned to Century Industries, "bonus payment" income assigned

to Holding Co. through Delta, Alpha, and CMS Investors, income

earned as trustee of Hi-Chicago Trust and assigned to Holding

Co., income assigned to and/or otherwise reported by the Bea

Ritch Trusts, and commission income from Equitable Leasing

assigned to IRA are underpayments attributable to tax-motivated

transactions within the meaning of section 6621(c)(3). We agree

with respondent.

With respect to 1980, as previously indicated with respect

to negligence, Kanter conceded the investment interest expense

deduction of $26,647 from SLG Partners through K & D Associates
 - 595 -

and introduced no evidence regarding his liability for additions

to tax or the increased interest rate of section 6621(c). The

Court has determined that the SLG transaction was a tax-motivated

transaction under section 6621(c). See HGA Cinema Trust v.

Commissioner, supra. Therefore, any underpayment resulting from

this adjustment or from any credits claimed from the SLG

transaction for the 1980 year is attributable to tax-motivated

transactions within the meaning of section 6621(c).

With respect to 1983 and 1986, Kanter introduced no evidence

that respondent erred in determining that the underpayments

resulting from the Schedule E computer adjustment of $83,333 for

1983 and Schedule E interest expense adjustment of $50,380 for

1986 were attributable to tax-motivated transactions. Therefore,

any underpayments resulting from these adjustments are

attributable to tax-motivated transactions within the meaning of

section 6621(c).

The capital gains and losses adjustment of $569,555 for 1983

relates to the sham transaction involving Cashmere. In the

Cashmere transaction, Kanter's liability for the increased

interest rate is established essentially by the sham nature of

the scheme wherein his primary objective was to sell his real

estate partnership interests and receive cash therefor while, at

the same time, escaping the recognition of gains associated with

the negative capital accounts inherent in such interests.
 - 596 -

With respect to the 1987 capital gains and losses adjustment

of $3,097,750, included therein is the disallowance of losses

claimed on the sale of notes receivable, stock, and partnership

interests to Windy City and MAF for nominal consideration.

Kanter admitted that the purpose of these sales was to establish

losses for tax purposes. As discussed in the disallowance of

these losses, the claimed losses were based on sham transactions

wholly lacking in economic substance. Consequently, any

underpayments resulting from these adjustments are attributable

to tax-motivated transactions within the meaning of section

6621(c).

Issue 37. Whether IRA Is Liable for the Section 6651(a)(1)
Addition to Tax for 1980

OPINION

In the notice of deficiency, respondent determined that IRA

was liable for an addition to tax under section 6651(a)(1) equal

to 15 percent of the deficiency for filing a delinquent return

for 1980.

Section 6651(a)(1) provides that if there is a failure to

file a return on the date prescribed therefor (determined with

regard to any extension of time for filing), unless it is shown

that such failure is due to reasonable cause and not due to

willful neglect, there will be added to the amount required to be

shown as tax on such return 5 percent of the amount of such tax

if the failure is not for more than 1 month, with an additional 5
 - 597 -

percent for each additional month or fraction thereof during

which such failure continues, not exceeding 25 percent in the

aggregate.

IRA failed to file timely its Federal income tax return for

1980. Although the due date for IRA's filing of its 1980 return

had been extended to September 15, 1981, the return was not

received by the Internal Revenue Service until on or about

November 21, 1981. See Issue 30. IRA has not shown that such

failure to file timely the return was due to reasonable cause and

was not due to willful neglect. Therefore, we hold that IRA is

liable for the section 6651(a)(1) addition to tax equal to 15

percent of the deficiency for 1980.

Issue 38. Whether IRA Is Liable for the Section 6653(a)
Additions to Tax for 1980, and 1982 Through 1988

OPINION

In the notices of deficiency to IRA for 1980 and 1982

through 1988, respondent determined that all of the underpayments

for each year were attributable to negligence or intentional

disregard of rules or regulations under section 6653(a).

IRA contends that it is not liable for the section 6653(a)

addition to tax because it reasonably relied upon the advice of

tax professionals, including Kanter and the certified public

accountants who maintained its books and prepared its tax

returns.
 - 598 -

Respondent, on the other hand, contends that IRA failed to

establish that it is not liable for the section 6653(a) addition

to tax.

We conclude that IRA is liable for the addition to tax under

section 6653(a) for 1980, 1982, 1983, 1984, 1985, 1986, 1987, and

1988, with respect to its underpayments from the equipment

leasing transactions adjustments (Issue 22). As previously

noted, Mallin, a tax attorney and an individual with considerable

experience in the leasing field, brokered the transactions and

recommended them to IRA and Kanter. Kanter further testified

that, in having IRA invest in these transactions, he relied upon

Mallin. However, it is important to note that Mallin was not

acting as an outside, disinterested, and independent adviser to

IRA, because he was paid a commission by the leasing company

based on IRA's cash investment in each transaction. Indeed,

during the course of Mallin's testimony, he acknowledged that he

was acting as a broker, not as a tax attorney, in brokering these

and other leasing transactions. Moreover, the Court did not

accept Mallin's conclusory claims regarding the transactions'

profit potential and economic substance. Also, no offering

memorandum or prospectus was prepared and furnished to IRA with

respect to the subject transactions. IRA failed to establish

that a reasonable inquiry was made into the merits of the

deductions and credits prior to its investment in these
 - 599 -

transactions. It was not shown that any of IRA's other advisers

had knowledge or had been apprised of all the relevant facts.

See Collins v. Commissioner, 857 F.2d 1383 (9th Cir. 1988), affg.

Dister v. Commissioner, T.C. Memo. 1987-217; Zmuda v.

Commissioner, 731 F.2d 1417 (9th Cir. 1984). Although reasonable

reliance on the advice of professionals may be a defense to

negligence, IRA did not show that the reliance in the instant

cases was reasonable. See Freytag v. Commissioner, 89 T.C. 849,

888 (1987), affd. 904 F.2d 1011 (5th Cir. 1990), affd. 501 U.S.

868 (1991). Consequently, we sustain respondent's determinations

that IRA is liable for the addition to tax for negligence or

intentional disregard of rules or regulations under section

6653(a) for 1980, 1983, 1984, 1985, and 1986 on the underpayments

from the equipment leasing transaction adjustments. These

section 6653(a) additions include (1) an addition to tax under

section 6653(a) for 1980, (2) an addition to tax under section

6653(a)(1) and (2) for 1983, 1984, and 1985, and (3) an addition

to tax under section 6653(a)(1)(A) and (B) for 1986.

We also conclude that IRA failed to establish that it acted

reasonably and in good faith in claiming the disallowed 1985

capital losses (Issue 25) from its purported sales of various

assets to Kanter and Holding Co. As discussed previously, IRA

failed to show that section 267 was inapplicable or that the

sales were bona fide. Consequently, we sustain respondent's
 - 600 -

determination that IRA is liable for the addition to tax under

section 6653(a)(1)(A) and (B) for 1985 on the underpayment from

the disallowed capital losses.

We also conclude that IRA failed to establish that it was

not negligent in claiming (1) the disallowed 1987 bad debt

deductions (Issue 26), (2) the disallowed 1987 ordinary losses

(Issue 27), and (3) the disallowed 1987 capital losses (Issue

28). IRA claimed the bad debt deductions with respect to the

promissory notes of Ballard and Lisle. There was no showing that

these debts were worthless. Moreover, IRA later pursued

collection efforts upon these notes, with the result that it

obtained payment from Ballard upon his notes and received Lisle's

renewed promise to pay his notes. Also, as to IRA's claimed

losses, IRA failed to show a reasonable basis for treating as

bona fide its purported sales of various assets to MAF.

Consequently, we sustain respondent's determination that IRA is

liable for the addition to tax under section 6653(a)(1)(A) and

(B) for 1987 on the underpayments from the disallowed losses and

bad debt deductions.

Lastly, we conclude that IRA failed to establish that it was

not negligent in claiming the disallowed 1988 $1,073,835 Decision

Holdings Form 4797 loss (Issue 23). IRA failed to show that it

was reasonable to claim that the TG limited partnership had a

basis of $1,091,641 in the assets that it transferred to Decision
 - 601 -

Holdings in a purported section 351 transaction. Consequently,

we sustain respondent's determination that IRA is liable for the

addition to tax under section 6653(a)(1)(A) and (B) for 1988 on

the underpayment from the disallowed Form 4797 loss.

Issue 39. Whether IRA Is Liable for the Section 6659(a)
Additions to Tax for 1982 and 1983

OPINION

Consistent with the previous discussion with respect to

Issues 22 and 23, a portion of each of the underpayments in

income tax for 1982 and 1983 is attributable to gross

overstatements by IRA as to the valuation of computer equipment

and the attempt to structure a transaction under section 351 to

realize a loss. In both instances, the transactions were factual

and legal shams, lacked economic substance, and lacked a profit

motive as well as a business purpose. See Rose v. Commissioner,

supra. In the section 351 situation, the transactions, under

section 357(b) and (c) had no bona fide business purpose, were

purposely intended to avoid Federal income tax, and the

liabilities to which the properties were subject exceeded the

adjusted bases of the properties. IRA presented no meaningful

evidence relating to the valuation of the computer equipment nor

evidence relating to the inapplicability of section 357(b) and

(c) in the section 351 transaction.

In our view, the underpayments of taxes shown on IRA's

income tax returns for the years in question are attributable to
 - 602 -

the prohibited conduct; i.e. the deliberate overvaluations. In

each of the transactions the indebtedness incurred by IRA/Cedilla

for purchase of the equipment greatly exceeded the amounts paid

by prior owners of the equipment, and no evidence was presented

to establish the reason for such increases in cost. IRA's

overvaluations with respect to the computer equipment are

inseparable from the transactions' lack of economic substance and

profit motive and their sham character. The same rationale

applies to the section 351 transaction. Accordingly, we sustain

respondent's determination that a portion of the underpayment for

each of the years 1982 and 1983 is attributable to a valuation

overstatement involving the equipment leasing transactions.

Issue 40. Whether IRA Is Liable for the Section 6661 Additions
to Tax for 1983 Through 1988

OPINION

This issue relates to the addition to tax under section 6661

for IRA's understatements of tax attributable to a number of

adjustments that we have sustained for 1983 through 1988.

In the notices of deficiency issued to IRA for 1983 through

1988, respondent determined that the entire deficiency for each

year was a substantial understatement of tax for which IRA was

liable for the addition to tax under section 6661(a).

IRA contends that it is not liable for the section 6661(a)

addition to tax because there was substantial authority for the

positions it took with respect to the disallowed items.
 - 603 -

Respondent, to the contrary, contends that IRA failed to

meet its burden of establishing that it was not liable for the

section 6661(a) additions.

We agree with respondent. IRA failed to establish that

substantial authority existed supporting its position on the

disallowed equipment leasing transaction items. (Issue 22). In

sustaining respondent's disallowance of the credits and

deductions claimed by IRA, we note that IRA failed to offer

probative evidence (1) that the equipment leasing transactions

had economic substance, and (2) that the long-term notes issued

were valid recourse indebtedness. Among other things, we did not

accept Mallin's conclusory opinions concerning the transactions'

profit potential and the reasonably expected residual value of

the equipment. Examinations into the economic substance of

leasing transactions are inherently factual, and, in conducting

the economic substance inquiry, significant objective factors

include the reasonableness of the income projections and residual

value projections. See Levy v. Commissioner, 91 T.C. 838, 856

(1988). Thus, IRA's reliance on other equipment leasing cases in

which taxpayers prevailed is inapposite. An authority is of

little relevance if it is distinguishable on its facts from the

facts of the case at issue. See sec. 1.6661-3(b), Income Tax

Regs.
 - 604 -

In addition, IRA did not show that (1) the disallowed

leasing transaction items were not tax shelter items, and (2) it

reasonably believed, at the time its returns were filed, that its

treatment of the items was more likely than not the proper

treatment. See sec. 1.6661-2(d), Income Tax Regs. Therefore, we

sustain respondent's determinations that IRA is liable for

additions to tax under section 6661 for 1983 through 1988 on the

understatements of tax attributable to the leasing transaction

items.

Similarly, we conclude that IRA failed to establish that it

had substantial authority for its treatment of the disallowed

1985 capital losses (Issue 25). In sustaining respondent's

disallowance of the losses, we found that IRA made no showing

that section 267 was inapplicable or that the losses were bona

fide. Consequently, we sustain respondent's determination that

IRA is liable for an addition to tax under section 6661(a) for

1985 on the understatement attributable to the capital loss

items.

The Court concludes that IRA failed to establish that it had

substantial authority for its treatment of (1) the disallowed bad

debt deductions (Issue 26), (2) the disallowed ordinary losses

(Issue 27), and (3) the disallowed capital losses (Issue 28). As

previously discussed, IRA failed to show that the debts, in fact,

became worthless during 1987. With respect to the 1987 ordinary
 - 605 -

and capital loss items, IRA failed to make any showing that (1)

the purported sales were bona fide transactions, and/or (2) that

section 267 was inapplicable. Moreover, with respect to the

purported sales of certain assets made to MAF, IRA also failed to

show that (1) the loss items were not tax shelter items, and (2)

it reasonably believed that its treatment of the items was more

likely than not the proper treatment. Consequently, we sustain

respondent's determination that IRA is liable for an addition to

tax under section 6661(a) for 1987 on the understatement from the

disallowed bad debt deduction, ordinary losses, and capital

losses items.

Finally, we conclude that IRA failed to establish that it

had substantial authority for its treatment of the disallowed

1988 Decision Holdings Form 4797 loss (Issue 23). IRA did not

show that the TG limited partnership had an adjusted basis of

$1,091,641 in the assets it transferred to Decision Holdings.

Moreover, IRA did not show that (1) this loss item was not a tax

shelter item, and (2) it reasonably believed its treatment of the

item was more likely than not the proper treatment. Therefore,

we sustain respondent's determination that IRA is liable for an

addition to tax under section 6661(a) for 1988 on the

understatement attributable to the disallowed Form 4797 loss

item.
 - 606 -

Issue 41. Whether IRA Is Liable for the Section 6662(a)
Accuracy-Related Penalty for 1989

OPINION

In the notice of deficiency for 1989, respondent determined

that IRA was liable for an accuracy-related penalty of $175,780

due to negligence or disregard of rules or regulations and a

substantial understatement of tax. IRA had the burden of proving

that the imposition of the accuracy-related penalty was

erroneous. It failed to do so. Therefore, we sustain

respondent's determination.

Conclusion

To reflect our disposition of the issues in controversy and

those settled or conceded by the parties,

Decisions in all dockets

will be entered under Rule

155.