Estate of Kanter v. Comm'r

T.C. Memo. 2007-21

UNITED STATES TAX COURT

ESTATE OF BURTON W. KANTER, DECEASED, JOSHUA S. KANTER,
EXECUTOR, AND NAOMI R. KANTER, ET AL.,1 Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 712-86, 1350-87, Filed February 1, 2007.
31301-87, 33557-87,
3456-88, 32103-88,
16421-90, 26251-90,
20211-91, 21555-91,
21616-91, 1984-92,
16164-92, 23743-92,
7557-93, 22884-93.

1
Cases of the following petitioners are consolidated
herewith: Estate of Burton W. Kanter, Deceased, Joshua S.
Kanter, Executor, and Naomi R. Kanter, docket Nos. 1350-87,
31301-87, 33557-87, 3456-88, 32103-88, and 26251-90; Claude M.
and Mary B. Ballard, docket Nos. 16421-90, 20211-91, 21616-91,
1984-92, 23743-92, and 22884-93; and 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 Nos.
21555-91, 16164-92, and 7557-93.
 -2-

Matthew J. Gries, Randall G. Dick, and N. Jerold Cohen, for

petitioner Estate of Burton W. Kanter, Deceased, Joshua S.

Kanter, Executor, in docket Nos. 712-86, 1350-87, 31301-87,

33557-87, 3456-88, 32103-88, and 26251-90.

Karen L. Hawkins, for petitioner Naomi R. Kanter in docket

Nos. 712-86, 1350-87, 31301-87, 33557-87, 3456-88, 32103-88, and

26251-90.

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

M. and Mary Ballard in docket Nos. 16421-90, 20211-91, 21616-91,

1984-92, 23743-92, and 22884-93, and for petitioners Estate of

Robert W. Lisle, Deceased, Thomas W. Lisle and Amy L. Albrecht,

Independent Co-Executors, and Estate of Donna M. Lisle, Deceased,

Thomas W. Lisle and Amy L. Albrecht, Independent Co-Executors, in

docket Nos. 21555-91, 16164-92, and 7557-93.

John J. Comeau, Frederic J. Fernandez, James M. Klein, and

Mark J. Miller, for respondent.

CONTENTS

I. Procedural History . . . . . . . . . . . . . . . . . . . 12

II. Amendment to Rule 183 . . . . . . . . . . . . . . . . . 17

III. Notices of Deficiency . . . . . . . . . . . . . . . . . 19

IV. New Rule 183 and the Court’s Review and Adoption
Procedure . . . . . . . . . . . . . . . . . . . . . . . 26

V. Standard of Deference Due to General Findings of Fact and
Credibility Determinations Contained in the STJ Report . 28
 -3-

VI. Structure of the Court’s Report . . . . . . . . . . . . 35

ISSUE I. Whether Kanter, Ballard, and Lisle Earned and Are
Taxable on the Income in Dispute . . . . . . . . . 37
FINDINGS OF FACT
I. Petitioners . . . . . . . . . . . . . . . . . . . . . . . 38
A. Burton W. Kanter . . . . . . . . . . . . . . . . . 38
B. Claude M. Ballard . . . . . . . . . . . . . . . . . 41
C. Robert W. Lisle . . . . . . . . . . . . . . . . . . 43
D. Additional Findings of Fact Regarding Ballard
and Lisle . . . . . . . . . . . . . . . . . . . . . 45
1. Ballard . . . . . . . . . . . . . . . . . . . . 45
2. Lisle . . . . . . . . . . . . . . . . . . . . . 46
E. Kanter-Related Entities . . . . . . . . . . . . . . 47
1. Investment Research Associates, Ltd.(IRA) . . . 47
a. IRA’s Shareholders . . . . . . . . . . . . 48
b. The Bea Ritch Trusts . . . . . . . . . . . 49
c. IRA’s Officers and Directors . . . . . . . 50
d. IRA’s Subsidiaries . . . . . . . . . . . . 52
e. IRA’s Business Activities . . . . . . . . . 53
2. Carlco, Inc., TMT, Inc., and BWK, Inc. . . . . 53
3. Additional Findings of Fact Regarding The
Holding Co. . . . . . . . . . . . . . . . . . . 56
a. THC’s Shareholders, Officers,
and Directors . . . . . . . . . . . . . . . 57
b. THC’s Tax Returns . . . . . . . . . . . . . 58
4. The Administration Co., Inc., and Principal
Services Accounting Corp. . . . . . . . . . . . 59
II. Introductory Statement and Brief Introduction of The
Five . . . . . . . . . . . . . . . . . . . . . . . . . . 66
A. The STJ Report . . . . . . . . . . . . . . . . . 66
B. Comments Regarding the Introductory Statement
and Brief Introduction of The Five . . . . . . . . 71
III. Details Regarding The Five . . . . . . . . . . . . . . 73
A. Certain Payments Made by The Five . . . . . . . . 73
1. Hyatt Corp.’s Payment of a Share of Its
Profits on the Embarcadero Hotel’s Management
Contract to KWJ Corp. . . . . . . . . . . . . . 74
2. Bruce Frey’s Payments to IRA From 1980 Through
1985 and to THC in 1981, 1983, 1984, and 1987 . 91
a. The Frey/THC Agreement . . . . . . . . . . 100
b. The Frey/Zeus Agreement . . . . . . . . . . 102
c. BJF Partnership . . . . . . . . . . . . . . 104
d. Summary of Frey Payments to Zeus . . . . . 106
e. Summary of Frey Payments to THC . . . . . . 107
3. Payments From William Schaffel to IRA From
1979 Through 1983 and to THC From 1984
Through 1986 . . . . . . . . . . . . . . . . . 107
 -4-

a. Sale of IBM Building . . . . . . . . . . . 110
b. Torcon Transactions With Prudential . . . . 110
c. Walters’s Transactions With Prudential . . 112
d. Walters’s Transactions With Travelers . . . 113
e. Schaffel’s Payments to IRA and THC . . . . 116
f. Four Ponds, FPC Subventure, and One River
Partnerships . . . . . . . . . . . . . . . 118
(i). Four Ponds Partnership . . . . . 118
(ii). FPC Subventure Partnership . . . 119
(iii). One River Partnership . . . . . . 119
(iv). Meyers’s Memorandum Regarding
Four Ponds Partnership . . . . . 120
(v). FPC Subventure’s Tax Returns . . 122
4. Schnitzer/PMS Payments From 1979 Through 1989 . 124
5. Payments from Eulich/Essex Partnership to
IRA and THC From 1982 Through 1989 . . . . . . 131
a. John Eulich . . . . . . . . . . . . . . . 131
b. Allen Ostroff . . . . . . . . . . . . . . 133
c. Hotel Management Industry Trends . . . . . 134
d. The Gateway Hilton and John Connolly . . . 135
e. Gateway Hotel Management Co. and Essex
Corp . . . . . . . . . . . . . . . . . . . 138
f. MHM and GHM Hotel Management Contracts . . 140
g. Essex Partnership . . . . . . . . . . . . 141
h. Essex Partnership Operations . . . . . . . 144
i. GHM’s and MHM’s Representation and
Marketing Agreements . . . . . . . . . . . 145
j. Transfer of IRA’s Essex Partnership
Interest . . . . . . . . . . . . . . . . . 151
k. Payments to Essex Partnership and Essex
Partnership Distributions . . . . . . . . 152
B. Certain Loans, Payments, and Other Benefits That
Ballard and Lisle and/or Their Family Members
Received . . . . . . . . . . . . . . . . . . . . . 153
IV. Additional Findings of Fact: The Flow of Funds . . . . . 159
A. Payments Made by The Five to IRA and Its
Subsidiaries From 1977 to 1989 . . . . . . . . . . 160
1. Payments Made During 1977 Through 1983 . . . . 162
2. Payments Made During 1984 to 1989 . . . . . . . 164
B. Distribution of the Funds Paid by The Five in
Connection With the Various Prudential
Transactions to Kanter, Ballard, Lisle, and Their
Respective Family Members . . . . . . . . . . . . . 166
1. Additional Details Regarding Management and
Control of Carlco, TMT and BWK . . . . . . . . 166
a. Carlco . . . . . . . . . . . . . . . . . . 166
b. TMT . . . . . . . . . . . . . . . . . . . 167
c. BWK . . . . . . . . . . . . . . . . . . . 167
 -5-

2. IRA’s Transfers to Carlco, TMT and BWK of
Funds Paid by The Five . . . . . . . . . . . 168
a. Funds Paid by The Five to IRA During 1977
Through 1983 Transferred to Carlco, TMT,
and BWK . . . . . . . . . . . . . . . . . 168
(i). Transfers From Zeus to IRA . . . 169
(ii). IRA’s Transfer of Its Interest
in Essex Partnership . . . . . . 170
(iii). IRA’s Transfer of Its Interest
in Sherwood Partnership . . . . . 171
(iv). Accounting Treatment . . . . . . 172
(v). Additional Capital Contributions
to Sherwood Partnership . . . . . 173
b. Transfer of Funds Paid by The Five During
1984 Through 1989 to Carlco, TMT, and BWK 174
(i). Hyatt Corp. . . . . . . . . . . . 174
(ii). Frey . . . . . . . . . . . . . . 176
(iii). Schnitzer/PMS . . . . . . . . . . 176
(iv). Essex Partnership . . . . . . . . 176
c. Carlco, TMT, and BWK Capital Accounts . . 177
3. The Disposition of Funds From Carlco, TMT, and
BWK for the Benefit of Ballard, Lisle, Kanter,
and Their Families . . . . . . . . . . . . . . 178
a. Ballard’s Use and Enjoyment of TMT’s
Assets . . . . . . . . . . . . . . . . . . 178
(i). TMT’s Various Accounts . . . . . 178
(ii). Loans From TMT to Ballard and
Ballard Entities . . . . . . . . 178
(iii). TMT’s Property Transferred to
Ballard . . . . . . . . . . . . . 181
(iv). Investment in Melinda Ballard’s
Company . . . . . . . . . . . . . 184
(v). Ballard’s Disclosures to
Goldman Sachs . . . . . . . . . . 185
(vi). TMT’s Assets . . . . . . . . . . 187
b. Lisle’s Use and Enjoyment of Carlco’s
Assets . . . . . . . . . . . . . . . . . . 188
(i). Carlco’s Various Accounts . . . . 188
(ii). Lisle’s Personal Use of Carlco’s
Funds . . . . . . . . . . . . . 189
(iii). Carlco’s Assets . . . . . . . . 189
c. Kanter’s Use and Enjoyment of BWK’s
Assets . . . . . . . . . . . . . . . . . . 190
(i). Salaries and Officer Compensation
Paid to Kanter and His Son . . . 190
(ii). Loans . . . . . . . . . . . . . 190
(iii). Gifts . . . . . . . . . . . . . 191
 -6-

C. Other Means Used To Transfer Funds for the
Benefit of Ballard, Lisle, Kanter, and Their
Respective Families . . . . . . . . . . . . . . . . 191
1. Payments From IRA, KWJ Corp., and KWJ
Partnership . . . . . . . . . . . . . . . . . . 191
a. IRA Payments to Ballard and
Lisle in 1982 . . . . . . . . . . . . . . 191
b. Consulting Fees Paid by KWJ Corp.
and KWJ Partnership to Ballard’s
and Lisle’s Adult Children . . . . . . . . 192
2. Additional Loans . . . . . . . . . . . . . . . 194
a. IRA Loans to Kanter . . . . . . . . . . . 194
b. Loans to Ballard, Lisle, Their Family
Members, and Their Trusts . . . . . . . 194
(i). Ballard’s Grantor Trusts . . . . 194
(ii). Lisle’s Grantor Trusts . . . . . 195
(iii). International Films, Inc. . . . . 196
(iv). Harbor Exchange Lending Operation 196
(v). Loans to Lisle and His Trusts. . 197
(vi). Loans to the Ballards and
Their Trusts . . . . . . . . . . 197
(vii). Writeoff of Loans and Claimed
Losses. . . . . . . . . . . . . . 197
(viii). Loans to Lisle’s RWL Cinema
Trust During 1988 to 1990 . . . . 205
D. Summary of Funds Paid by The Five to IRA and
Disposition of Those Funds for the Benefit of
Kanter, Ballard, Lisle, and Their Families . . . . 205
E. Payments Made by The Five to THC and Its
Subsidiaries During 1981 Through 1989 . . . . . . . 207
F. Distribution of Funds From THC to Kanter . . . . . 208
G. The Flow of Funds From Four Ponds and One River
Through FPC Subventure to Kanter and Lisle . . . . 211
V. Additional Findings of Fact Regarding the Examination
Process and Summons Enforcement Proceedings . . . . . . . 213
A. Failure To Cooperate During the Audit . . . . . . . 213
B. IRS Summonses . . . . . . . . . . . . . . . . . . . 214
C. Summons Enforcement . . . . . . . . . . . . . . . . 215
D. Requests for Production of Documents . . . . . . . 219
OPINION
A. The Parties’ Positions . . . . . . . . . . . . . . 222
B. The Assignment of Income Doctrine . . . . . . . . . 224
C. Errors in the STJ Report . . . . . . . . . . . . . 228
1. The STJ Report Reflects a Misunderstanding of
Respondent’s Theory Regarding the Kickback
Scheme . . . . . . . . . . . . . . . . . . . . 229
2. Discussion Regarding Assignment of Income . . 231
 -7-

3. Failure To Address Respondent’s Flow-of-Funds
Argument . . . . . . . . . . . . . . . . . . . 232
4. Incomplete Discussion Regarding Loan
Arrangements . . . . . . . . . . . . . . . . . 232
5. Discussion Regarding Consulting Payments to
Ballard’s and Lisle’s Adult Children . . . . . 234
6. Manifestly Unreasonable Credibility
Determinations . . . . . . . . . . . . . . . . 235
a. Testimony Offered by The Five . . . . . . 235
b. Ballard’s Testimony Regarding the Hyatt
Transaction . . . . . . . . . . . . . . . 235
c. Kanter’s Testimony Regarding
Deconsolidation . . . . . . . . . . . . . 236
d. Kanter’s Testimony Regarding IRA . . . . . 237
e. Kanter’s, Ballard’s, and Lisle’s Denials 237
D. Summary of Kanter’s, Ballard’s and Lisle’s
Transactions With The Five . . . . . . . . . . . . 238
1. An Overview . . . . . . . . . . . . . . . . . . 238
2. The Hyatt Transaction . . . . . . . . . . . . . 244
3. Shaffel . . . . . . . . . . . . . . . . . . . . 249
4. Frey . . . . . . . . . . . . . . . . . . . . . 253
5. Schnitzer/PMS . . . . . . . . . . . . . . . . . 257
6. Eulich/Essex Partnership . . . . . . . . . . . 260
E. Flow-of-Funds Analysis . . . . . . . . . . . . . . 267
1. Payments to IRA: 1977 Through 1983 . . . . . . 268
2. Payments to IRA: 1984 Through 1989 . . . . . . 269
3. IRA Loans to Kanter, Ballard, and Lisle . . . . 270
a. IRA Loans to Ballard and Ballard’s Trusts 270
b. IRA Loans to Lisle and Lisle’s Trusts . . 270
c. Sale of Grantor Trust Notes for $1 . . . . 271
d. IRA Loans to Kanter . . . . . . . . . . . 271
e. Additional Loans to Lisle’s Grantor Trust 272
f. Consulting Payments to Ballard’s and
Lisle’s Adult Children . . . . . . . . . . 272
4. Payments to THC: 1981 to 1989 . . . . . . . . 273
a. FPC Subventure Partnership . . . . . . . . 274
b. THC Transfers to Kanter . . . . . . . . . 276
F. Kanter-Related Entities Were Shams . . . . . . . . 276
1. IRA and THC . . . . . . . . . . . . . . . . . . 276
2. Carlco, TMT, and BWK . . . . . . . . . . . . . 278
a. Diversification and Deconsolidation . . . 278
b. Use and Enjoyment of Carlco’s, TMT’s,
and BWK’s Assets . . . . . . . . . . . . . 282
(i). Carlco . . . . . . . . . . . . . 282
(ii). TMT . . . . . . . . . . . . . . . 283
(iii). BWK . . . . . . . . . . . . . . . 287
G. Cracks in the Kanter Facade . . . . . . . . . . . . 288
1. The Hyatt Transaction . . . . . . . . . . . . . 288
 -8-

2. Frey . . . . . . . . . . . . . . . . . . . . . 289
3. Schaffel . . . . . . . . . . . . . . . . . . . 290
4. Schnitzer/PMS . . . . . . . . . . . . . . . . . 291
5. Loans to Ballard . . . . . . . . . . . . . . . 292
6. Ballard’s Disclosures to Goldman Sachs . . . . 292
7. Kanters’s Letters to the Ballard and Lisle
Children . . . . . . . . . . . . . . . . . . . 293
H. Conclusion and Schedule of Income Adjustments . . . 295

ISSUE II. Whether Kanter and Ballard Are Liable for
Additions to Tax for Fraud . . . . . . . . . . . . 298
OPINION
A. Failure To Report Substantial Amounts of Income . . 300
B. Concealment of the True Nature of the Income and
the Identity of the Earners of the Income . . . . . 301
C. Use of Sham, Conduit, and Nominee Entities . . . . 301
D. Reporting Kanter’s and Ballard’s Income on IRA’s
and THC’s Tax Returns . . . . . . . . . . . . . . . 302
E. Commingling of Kanter’s and Ballard’s Income With
Funds Belonging to Others . . . . . . . . . . . . . 303
F. Phony Loans . . . . . . . . . . . . . . . . . . . . 303
G. False and Misleading Documents . . . . . . . . . . 304
H. Failure to Cooperate During the Examination Process 304
I. Conclusion . . . . . . . . . . . . . . . . . . . . 306

ISSUE III. Whether Commitment Fees Paid to Century
Industries, Ltd., During 1981 to 1984 and 1986
are Includable in Kanter’s Income . . . . . . . . 307
FINDINGS OF FACT
OPINION
A. The Parties’ Arguments . . . . . . . . . . . . . . 316
B. TEFRA Partnership Provisions . . . . . . . . . . . 317
C. The STJ Report . . . . . . . . . . . . . . . . . . 318
D. Analysis . . . . . . . . . . . . . . . . . . . . . 319

ISSUE IV. Whether Kanter Received Unreported Income From
Hi-Chicago Trust During 1981 to 1983 . . . . . . . 324
FINDINGS OF FACT
OPINION
A. The Assignment of Income Doctrine . . . . . . . . . 326
B. The Parties’ Arguments . . . . . . . . . . . . . . 327
C. Analysis . . . . . . . . . . . . . . . . . . . . . 327

ISSUE V. Whether Kanter Is Taxable on Income Attributed
to the Bea Ritch Trusts for 1986 and 1987 . . . . . 330
FINDINGS OF FACT
A. The Bea Ritch Trusts . . . . . . . . . . . . . . . 330
B. Oyster Bay Associates Partnership . . . . . . . . . 332
 -9-

OPINION
A. Grantor Trust Provisions of Sections 671 Through
678 . . . . . . . . . . . . . . . . . . . . . . . . 341
B. The Parties’ Arguments . . . . . . . . . . . . . . 343
C. The STJ Report . . . . . . . . . . . . . . . . . . 344
D. Analysis . . . . . . . . . . . . . . . . . . . . . 345

ISSUE VI. Whether Kanter Received Unreported Income From
CMS Investors Partnership for 1982 to 1984
and 1987 to 1989 . . . . . . . . . . . . . . . . . 349
FINDINGS OF FACT
OPINION
A. The Parties’ Arguments . . . . . . . . . . . . . . 352
B. Analysis . . . . . . . . . . . . . . . . . . . . . 354
1. Subject Matter Jurisdiction . . . . . . . . . . 354
2. Whether Kanter Improperly Assigned Income to
THC Through CMS Investors . . . . . . . . . . . 356

ISSUE VII. Whether Kanter Received Unreported Income From
Equitable Leasing Co., Inc., During 1983 . . . . 357
FINDINGS OF FACT
OPINION

ISSUE VIII. Whether Kanter Received Unreported Income
for 1982 According to the Bank Deposits Method
of Income Reconstruction . . . . . . . . . . . . 361
FINDINGS OF FACT
OPINION
A. The Commissioner’s Use of the Bank Deposits
Method of Income Reconstruction . . . . . . . . . . 363
B. The Parties’ Arguments . . . . . . . . . . . . . . 364
C. The STJ Report . . . . . . . . . . . . . . . . . . 365
D. Analysis . . . . . . . . . . . . . . . . . . . . . 365

ISSUE IX. Whether Kanter Received Barter Income From
Principal Services Accounting Corp. During 1988
and 1989. . . . . . . . . . . . . . . . . . . . . 367

ISSUE X. Whether the Kanters Received Unreported Interest
Income During 1988 . . . . . . . . . . . . . . . . 368

ISSUE XI. Whether the Kanters Are Entitled to Certain
Deductions They Claimed on Schedules A and C
for 1986 to 1989 . . . . . . . . . . . . . . . . . 368
FINDINGS OF FACT
OPINION
A. The Parties’ Arguments . . . . . . . . . . . . . . 372
B. Analysis . . . . . . . . . . . . . . . . . . . . . 372
 -10-

ISSUE XII. Whether Kanter Realized and Must Recognize
Capital Gains as a Result of Transactions
Involving Cashmere Investments Associates, Inc.,
During 1983 and Whether the Kanters May Use
the Installment Method To Report Gains . . . . . 374
FINDINGS OF FACT
A. Transfer of Real Estate Partnership Interests
to Cashmere . . . . . . . . . . . . . . . . . . . . 380
B. Sale of Cashmere Stock to Waco . . . . . . . . . . 383
C. Sale of Cashmere Stock From Waco to Zell . . . . . 386
OPINION
A. The Parties’ Arguments . . . . . . . . . . . . . . 387
B. Analysis . . . . . . . . . . . . . . . . . . . . . 389
1. Applicability of Section 357(b)(1) . . . . . . 391
2. Applicability of Section 357(c) . . . . . . . . 392
3. Kanter’s Use of the Installment Method . . . . 394

ISSUE XIII. Whether Kanter Is Entitled to Research and
Development and Business Expense Deductions
Related to Immunological Research Corp.
for 1979 . . . . . . . . . . . . . . . . . . . . 396
FINDINGS OF FACT
OPINION
A. Trade or Business Requirement of Section 174 . . . 404
B. The Parties’ Arguments . . . . . . . . . . . . . . 407
C. Analysis . . . . . . . . . . . . . . . . . . . . . 408

ISSUE XIV. Whether Kanter Received Unreported Partnership
Income During 1978 . . . . . . . . . . . . . . . 415
FINDINGS OF FACT
OPINION

ISSUE XV. Whether the Kanters Are Entitled to a Loss From
GLS Associates for 1981 . . . . . . . . . . . . . 417
OPINION

ISSUE XVI. Whether the Kanters Are Entitled to Losses From
Equitec for 1983 and 1984 . . . . . . . . . . . . 420
OPINION
A. The Parties’ Arguments . . . . . . . . . . . . . . 420
B. Analysis . . . . . . . . . . . . . . . . . . . . . 421

ISSUE XVII. Whether the Kanters Are Entitled to an Investment
Interest Expense Deduction for 1981 . . . . . . 421
OPINION
A. The Parties’ Arguments . . . . . . . . . . . . . . 422
B. Analysis . . . . . . . . . . . . . . . . . . . . . 422
 -11-

ISSUE XVIII. Whether the Kanters Are Entitled to an
Investment Tax Credit Carryover for 1978 . . . 423
OPINION
A. The Parties’ Arguments . . . . . . . . . . . . . . 423
B. Analysis . . . . . . . . . . . . . . . . . . . . . 424

ISSUE XIX. Whether the Kanters Are Entitled to an
Interest Deduction for 1986 . . . . . . . . . . . 426
OPINION
A. The Parties’ Arguments . . . . . . . . . . . . . . 426
B. Analysis . . . . . . . . . . . . . . . . . . . . . 427

ISSUE XX. Whether the Kanters Are Entitled to a Business
Deduction of $104,231 for 1980 . . . . . . . . . . 429
OPINION
A. The STJ Report . . . . . . . . . . . . . . . . . . 429
B. The Parties’ Arguments . . . . . . . . . . . . . . 429

ISSUE XXI. Whether the Kanters Are Entitled to a Deduction
for a Charitable Contribution to the Jewish
United Fund for 1982 . . . . . . . . . . . . . . 430
FINDINGS OF FACT
OPINION
A. The Parties’ Arguments . . . . . . . . . . . . . . 431
B. The STJ Report . . . . . . . . . . . . . . . . . . 432
C. Analysis . . . . . . . . . . . . . . . . . . . . . 432

ISSUE XXII. Whether Kanter Is Liable for Self-Employment
Tax for 1982 . . . . . . . . . . . . . . . . . . 434
OPINION

ISSUE XXIII. Whether the Kanters Realized Capital Gains
and Losses as Reported on Their 1987 Tax
Return . . . . . . . . . . . . . . . . . . . . 434

ISSUE XXIV. Additions to Tax and Related Matters . . . . . . 435
OPINION

APPENDIXES

Appendix 1 . . . . . . . . . . . . . . . . . . . . . . . . . 437
Appendix 2 . . . . . . . . . . . . . . . . . . . . . . . . . 238
Appendix 3 . . . . . . . . . . . . . . . . . . . . . . . . . 439
Appendix 4 . . . . . . . . . . . . . . . . . . . . . . . . . 440
Appendix 5 . . . . . . . . . . . . . . . . . . . . . . . . . 441
Appendix 6 . . . . . . . . . . . . . . . . . . . . . . . . . 443
Appendix 7 . . . . . . . . . . . . . . . . . . . . . . . . . 444
 -12-

Appendix 8 . . . . . . . . . . . . . . . . . . . . . . . . . 445
Appendix 9 . . . . . . . . . . . . . . . . . . . . . . . . . 446
Appendix 10 . . . . . . . . . . . . . . . . . . . . . . . . . 447
Appendix 11 . . . . . . . . . . . . . . . . . . . . . . . . . 448
Appendix 12 . . . . . . . . . . . . . . . . . . . . . . . . . 449
Appendix 13 . . . . . . . . . . . . . . . . . . . . . . . . . 451
Appendix 14 . . . . . . . . . . . . . . . . . . . . . . . . . 452
Appendix 15 . . . . . . . . . . . . . . . . . . . . . . . . . 453
Appendix 16 . . . . . . . . . . . . . . . . . . . . . . . . . 454
Appendix 17 . . . . . . . . . . . . . . . . . . . . . . . . . 455

MEMORANDUM FINDINGS OF FACT AND OPINION

HAINES, Judge: These consolidated cases are before the

Court on separate remands from the U.S. Courts of Appeals for the

Fifth, Seventh, and Eleventh Circuits2 for further proceedings

consistent with the Supreme Court’s opinion in Ballard v.

Commissioner, 544 U.S. 40 (2005), revg. 321 F.3d 1037 (11th Cir.

2003) and Estate of Kanter v. Commissioner, 337 F.3d 833 (7th

Cir. 2003).

I. Procedural History

These cases, along with a number of cases instituted by

another taxpayer, Investment Research Associates, Ltd.,

originally were consolidated for trial, briefing, and opinion.

Special Trial Judge D. Irvin Couvillion tried the cases but was

statutorily prohibited from entering the decisions. See sec.

2
See Estate of Kanter v. Commissioner, 406 F.3d 933 (7th
Cir. 2005); Ballard v. Commissioner, 429 F.3d 1026 (11th Cir.
2005); Estate of Lisle v. Commissioner, 431 F.3d 439 (5th Cir.
2005).
 -13-

7443A(c).3 Special Trial Judge Couvillion prepared an initial

report that included his recommended findings of fact and opinion

(the STJ report). The cases were then assigned to Judge Howard

A. Dawson, Jr., for adoption of the STJ report and entry of

decisions. Under Rule 183 as in effect at the time, the STJ

report was not filed or otherwise entered into the record of the

cases.4 Special Trial Judge Couvillion subsequently collaborated

with Judge Dawson in preparing a final report, Inv. Research

Associates, Ltd. v. Commissioner, T.C. Memo. 1999-407, in which

the Court sustained, inter alia, respondent’s determinations that

petitioners Burton W. Kanter (Kanter),5 Claude M. Ballard

(Ballard), and Robert W. Lisle (Lisle)6 (collectively

petitioners) failed to report income from a kickback scheme and

were liable for additions to tax for fraud. The Court also

sustained a number of adjustments respondent determined with

3
Unless otherwise indicated, section references are to
sections of the Internal Revenue Code, as amended, and Rule
references are to the Tax Court Rules of Practice and Procedure.
4
As discussed in greater detail below, Rule 183 was
amended effective Sept. 20, 2005. We shall refer to the amended
Rule as new Rule 183.
5
Burton W. Kanter died on Oct. 31, 2001--after he
testified at the trial in the consolidated cases. Thereafter,
his estate was substituted as a party in each of his dockets.
6
Robert W. Lisle died before the trial in the consolidated
cases, and his estate was substituted as a party in each of his
dockets.
 -14-

regard to Kanter that were unrelated to the alleged kickback

scheme.

Following entry of decisions, Kanter, Ballard, and Lisle

appealed their cases to separate Courts of Appeals.7 In Ballard

v. Commissioner, 321 F.3d 1037 (11th Cir. 2003), and Estate of

Kanter v. Commissioner, 337 F.3d 833 (7th Cir. 2003), the Courts

of Appeals for the Eleventh and Seventh Circuits, respectively,

affirmed this Court’s holdings that (1) Ballard and Kanter failed

to report income from the alleged kickback scheme, and (2) each

was liable for additions to tax for fraud.8 The Courts of

Appeals also affirmed this Court’s earlier ruling that it was not

obliged to make the STJ report part of the record. In Estate of

Lisle v. Commissioner, 341 F.3d 364 (5th Cir. 2003), the Court of

Appeals for the Fifth Circuit affirmed this Court’s holding that

7
In Inv. Research Associates, Ltd. v. Commissioner, T.C.
Memo. 1999-407, the Court sustained a number of adjustments
respondent determined with regard to the tax liability of
Investment Research Associates, Ltd. (IRA). The Court entered
decisions in all IRA dockets on Sept. 24, 2001. No appeal having
been filed, the Court’s decisions in the IRA cases are now final.
See secs. 7481(a)(1), 7483.

The Kanters did not appeal the decisions entered in their
cases at docket Nos. 24002-91 (taxable year 1987), 26918-92
(taxable year 1988), and 25981-93 (taxable year 1989). These
decisions were entered on Sept. 24, 2001, and are now final. See
secs. 7481(a)(1), 7483.
8
In Estate of Kanter v. Commissioner, 337 F.3d 833, 854-
857 (7th Cir. 2003), the Court of Appeals for the Seventh Circuit
also affirmed and reversed this Court’s holdings with regard to
several issues that related solely to Kanter.
 -15-

the Estate of Lisle was liable for tax deficiencies related to

the alleged kickback scheme for the years 1987 to 1989 but

reversed this Court’s holding that the Estate of Lisle was liable

for additions to tax for fraud.

Ballard and Kanter filed petitions for certiorari with the

Supreme Court. The Estate of Lisle did not file a petition for

certiorari.

In Ballard v. Commissioner, 544 U.S. 40 (2005), the Supreme

Court concluded (1) the collaborative process this Court employed

in the review of the STJ report and adoption of the Court’s

Memorandum Opinion in Inv. Research Associates, Ltd. v.

Commissioner, supra, was not warranted by or described in the

Court’s Rules of Practice and Procedure, and (2) the STJ report

was required to be included in the record to permit fully

informed appellate review regarding the question whether the

Special Trial Judge’s “credibility and other findings made in

that report were accorded ‘[d]ue regard’ and were ‘presumed . . .

correct’”. Ballard v. Commissioner, supra at 60. Thus, the

Supreme Court reversed the judgments of the Courts of Appeals for

the Seventh and Eleventh Circuits and remanded the cases for

further proceedings consistent with its opinion.

In Estate of Kanter v. Commissioner, 406 F.3d 933, 934 (7th

Cir. 2005), the Court of Appeals for the Seventh Circuit remanded

the Kanter cases to this Court “for further proceedings
 -16-

consistent with the Supreme Court’s decision in Estate of Burton

W. Kanter v. Commissioner of Internal Revenue, No. 03-1034.”

In Ballard v. Commissioner, 429 F.3d 1026, 1027 (11th Cir.

2005), the Court of Appeals for the Eleventh Circuit remanded the

Ballard cases to this Court with the following instructions:

(1) The “collaborative report and opinion” of the Tax
Court is ordered stricken; (2) The original report of
the special trial judge is ordered reinstated; (3) The
Chief Judge of the Tax Court is instructed to assign
this matter to a regular Tax Court Judge who had no
involvement in the preparation of the aforementioned
“collaborative report;” (4) The Tax Court shall proceed
to review this matter in accordance with the dictates
of the Supreme Court, and with the Tax Court’s newly
revised Rules 182 and 183, giving “due regard” to the
credibility determinations of the special trial judge
and presuming correct fact findings of the trial judge.
* * *

The Court of Appeals also stated that Special Trial Judge

Couvillion’s findings of fact are to be presumed correct “unless

manifestly unreasonable”. Id. at 1032.

In Estate of Lisle v. Commissioner, 431 F.3d 439 (5th Cir.

2005), the Court of Appeals for the Fifth Circuit recalled its

earlier mandate and directed this Court to reexamine the question

whether the Estate of Lisle is liable for tax deficiencies

consistent with the instructions handed down by the Court of

Appeals for the Eleventh Circuit in Ballard v. Commissioner, 429

F.3d at 1027.9

9
The Court of Appeals for the Fifth Circuit’s mandate in
the Lisle cases includes a reference to the case filed with this
Court at docket No. 20219-91. However, the Court’s decision in
(continued...)
 -17-

Following the remands, these cases were assigned to Judge

Harry A. Haines, a Judge who was not involved in the prior

proceedings in these cases.10

II. Amendment to Rule 183

In response to the Supreme Court’s holding in Ballard v.

Commissioner, 544 U.S. 40 (2005), the Court amended Rule 183 to

provide a procedure for service on the parties of a Special Trial

Judge’s recommended findings of fact and conclusions of law and

the filing of objections and responses. The pertinent portions

of new Rule 183 state as follows:

(c) Objections: Within 45 days after the service of
the recommended findings of fact and conclusions of
law, a party may serve and file specific, written
objections to the recommended findings of fact and
conclusions of law. A party may respond to another
party’s objections within 30 days after being served
with a copy thereof. The above time periods may be
extended by the Special Trial Judge. After the time
for objections and responses has passed, the Chief
Judge shall assign the case to a Judge for preparation
of a report in accordance with Code section 7460.

9
(...continued)
that case, i.e., that there is no deficiency and no addition to
tax due from the Lisles for the taxable year 1984, was entered
Nov. 20, 2003, and is otherwise final. See secs. 7481(a)(1),
7483. Although the Clerk of the Court notified the Court of
Appeals for the Fifth Circuit of this discrepancy, the Court has
received no further instruction from the Court of Appeals on this
point. Under the circumstances, the Court will assume that
docket No. 20219-91 was included in the Court of Appeals’ mandate
as the result of an inadvertent clerical error and docket No.
20219-91 shall remain closed.
10
Judges Mary Ann Cohen and Howard A. Dawson, Jr., and
Special Trial Judge D. Irvin Couvillion have taken no part in the
review of these cases on remand. See Ballard v. Commissioner,
429 F.3d at 1032 n.7.
 -18-

Unless a party shall have proposed a particular finding
of fact, or unless the party shall have objected to
another party’s proposed finding of fact, the Judge may
refuse to consider the party’s objection to the Special
Trial Judge’s recommended findings of fact and
conclusions of law for failure to make such a finding
or for inclusion of such finding proposed by the other
party, as the case may be. [Emphasis added.]

(d) Action on the Recommendations: The Judge to whom
the case is assigned may adopt the Special Trial
Judge’s recommended findings of fact and conclusions of
law, or may modify or reject them in whole or in part,
or may direct the filing of additional briefs, or may
receive further evidence, or may direct oral argument,
or may recommit the recommended findings of fact and
conclusions of law with instructions. The Judge’s
action on the Special Trial Judge’s recommended
findings of fact and conclusions of law shall be
reflected in the record by an appropriate order or
report. Due regard shall be given to the circumstance
that the Special Trial Judge had the opportunity to
evaluate the credibility of witnesses, and the findings
of fact recommended by the Special Trial Judge shall be
presumed to be correct.

Consistent with new Rule 183(c), the parties were served

with copies of the STJ report. In view of the recent amendment

to Rule 183, and the unique procedural posture of these cases,

the Court extended the dates within which the parties were

directed to file the objections and responses referred to in new

Rule 183(c). Respondent and Kanter filed objections to the STJ

report. Ballard and Lisle filed notices of no objection to the

STJ report. Kanter, Ballard, and Lisle filed responses to

respondent’s objection to the STJ report, and respondent filed a

response to Kanter’s objection to the STJ report.
 -19-

III. Notices of Deficiency

Respondent issued notices of deficiency to petitioners as

summarized below:

Burton W. and Naomi R. Kanter
Additions to Tax Penalty
Year Deficiency Sec. 6653 Sec. 6659 Sec. 6661 Sec. 6662

1978 $476,999.00 -- -- -- --
1979 183,909.37 $9,190.47 -- -- --
1980 454,396.00 22,720.00 -- -- --
1981 340,578.00 17,029.00 $42,682 -- --
1982 2,086,913.00 104,346.00 -- $208,691.00 --
1983 1,150,652.00 57,532.60 -- 287,663.00 --
1984 3,825,078.00 191,254.00 -- 949,211.00 --
1986 897,224.00 44,861.60 -- 223,666.00 --
1987 1,434,529.00 71,726.45 -- 358,632.25 --
1988 523,234.00 26,162.00 -- 130,809.00 --
1989 835,847.00 -- -- -- $167,169

Claude M. and Mary B. Ballard
Additions to Tax--Secs. Penalty
Year Deficiency 6651(a)(1) 6653 6659 6661 Sec. 6662

1975 $23,453 -- $1,173.00 -- -- --
1976 34,024 -- 1,701.00 -- -- --
1977 11,502 -- -- -- -- --
1978 3,923 -- -- -- -- --
1979 21,630 -- -- -- -- --
1980 92,481 -- -- -- -- --
1981 193,743 -- 9,687.00 $17,138 -- --
1982 55,338 -- 2,766.90 -- $8,744.00 --
1984 981,072 1
$51,331 88,788.05 -- 245,268.00 --
1987 208,449 -- 10,442.45 -- 52,112.25 --
1988 125,136 -- 6,257.00 -- -- --
1989 179,924 -- -- -- -- $35,985
1
Respondent conceded the addition to tax under sec. 6651(a)(1) for
the taxable year 1984.
 -20-

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
Year Deficiency Sec. 6653 Sec. 6661 Sec. 6662

1984 $827,955 $41,397.75 $206,988.75 --
1987 195,498 9,774.90 48,874.50 --
1988 109,048 5,452.00 27,262.00 --
1989 109,049 -- -- $21,810

Respondent determined in the notices of deficiency or

asserted in amended pleadings that the underpayments in tax were

subject to increased interest under section 6621(c), formerly

section 6621(d),11 as follows: Burton W. and Naomi R. Kanter for

the taxable years 1979,12 1980, 1982 to 1984, 1986, and 1987;

Claude M. and Mary B. Ballard for the taxable years 1975 to 1982,

1984, 1987, and 1988; and the Estates of Robert W. Lisle,

11
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. In the Tax Reform Act of 1986,
Pub. L. 99-514, sec. 1511(c), 100 Stat. 2744, sec. 6621(d)(1) was
redesignated sec. 6621(c)(1).
12
With respect to the Kanter case at docket No. 3456-88,
the applicability of sec. 6621(c) was asserted by respondent in
an amendment to answer and applies only to an underpayment in tax
of $206,239.63 attributable to a loss of $311,478 claimed by
petitioners from Immunological Research Corp., an S corporation,
which respondent disallowed. In a second amendment to answer,
respondent asserted the entire underpayment in tax for 1979 was
subject to increased interest under sec. 6621(c). On brief,
respondent concedes the underpayment attributable to the
disallowed loss from Immunological Research Corp. is not subject
to increased interest under sec. 6621(c) on the basis of Estate
of Cook v. Commissioner, T.C. Memo. 1993-581.
 -21-

Deceased, and Donna M. Lisle, Deceased, for the taxable years

1984, 1987, and 1988.

In amended pleadings, respondent asserted increases in the

deficiencies in tax and additions to tax for the taxpayers and

years as follows: Burton W. and Naomi R. Kanter for the taxable

years 1978 to 1984 and 1986 to 1989; Claude M. and Mary B.

Ballard for the taxable years 1975 to 1982, 1984, and 1987 to

1989; and Estates of Robert W. Lisle, Deceased, and Donna M.

Lisle, Deceased, for the taxable years 1984 and 1987 to 1989.

In the amended pleadings referred to above, respondent asserted

that (1) the underpayments of tax with respect to all or

substantial portions of the increased deficiencies in tax are

subject to the addition to tax for fraud pursuant to section

6653(b);13 and (2) in the alternative, if the Court holds that

petitioners are not liable for additions to tax for fraud, then

petitioners are liable for additions to tax under sections

6653(a)(1) and (2) and 6659(a) and increased interest under

13
For 1976 through 1981, the addition to tax for fraud is
set forth in sec. 6653(b). For 1982 through 1985, the addition
to tax for fraud is set forth in sec. 6653(b)(1) and (2). For
1986 and 1987, the addition to tax for fraud is set forth in sec.
6653(b)(1)(A) and (B). For 1988, the addition to tax for fraud
is set forth in sec. 6653(b)(1). For 1989, the penalty for fraud
is set forth in sec. 6663(a). By prior agreement among the
parties at a pretrial conference with the Court, respondent’s
amended pleadings and petitioners’ replies thereto were not filed
of record until the commencement of trial; however, the parties
exchanged these filings with each other well before the trial
date that was set by the Court.
 -22-

section 6621(c), or if the underpayment was for 1989, subject to

a penalty under section 6662.14

In the amended pleadings referred to above, respondent did

not calculate or assert the amounts of the increased tax

deficiencies or the amounts of the additions to tax or penalties.

Respondent generally asserted the amounts of increased income or

the amounts of disallowed expenses that would result in increased

deficiencies in tax and additions to tax. As a result of these

amended pleadings, and as a result of numerous concessions and

stipulations of settlement which were effected by the parties

before, during, and after the trial, as well as concessions of

14
As previously discussed, in Estate of Lisle v.
Commissioner, 341 F.3d 364 (5th Cir. 2003), the Court of Appeals
for the Fifth Circuit affirmed this Court’s holding that the
Estate of Lisle was liable for the deficiencies in dispute for
1987 to 1989 but reversed this Court’s holding that the Estate of
Lisle was liable for additions to tax for fraud (and therefore
assessment for the taxable year 1984 was barred by the period of
limitations). After the Lisle cases were first remanded to this
Court for entry of revised decisions (but before the Court of
Appeals recalled its mandate on Nov. 22, 2005), respondent
asserted the Court should sustain respondent’s alternative
determinations that the Estate of Lisle was liable for additions
to tax under secs. 6653(a)(1) and (2) and 6659(a), increased
interest under sec. 6621(c), and accuracy-related penalties under
sec. 6662. Petitioners disagreed and filed with the Court of
Appeals a document that was treated as a petition for writ of
mandamus. Although the Court of Appeals issued an order denying
the petition for writ of mandamus, the Court of Appeals intimated
that issues concerning alternative additions to tax were beyond
the scope of the remand. Consequently, the sole issue remaining
to be decided in the Estate of Lisle cases is whether the Estate
of Lisle is liable for the tax deficiencies determined in the
notices of deficiency for 1987 to 1989.
 -23-

certain issues by respondent on brief, Rule 155 computations will

be necessary in these cases.15

The parties settled several issues in these cases before and

during the trial. In addition, the parties’ objections and

responses to the STJ report narrowed the issues remaining in

dispute. The issues left to be decided are:

(1) Whether payments received by various entities associated

with Kanter during the years at issue represent income earned by

and properly taxable to Kanter, Ballard, and Lisle;

(2) if the Court sustains respondent’s determinations that

Kanter, Ballard, and Lisle are taxable on the payments in

question, whether Kanter and Ballard are liable for additions to

tax for fraud;

15
In several of the cases in which respondent filed
amended pleadings seeking increased deficiencies in tax and
additions to tax, respondent left blank the amounts of additional
income as to which increased deficiencies were asserted, with
footnotes stating that such “amounts will be provided later”.
Petitioners filed motions to strike respondent’s assertions of
increased deficiencies where the amounts of increased income or
disallowed expenses were not specifically asserted. The Court
denied petitioners’ motions but ordered respondent to file
amended pleadings by a designated date asserting the amounts of
increased income or disallowed expenses. Respondent filed
amended pleadings to comply with the Court’s order in all
pertinent cases except two: Docket Nos. 31301-87 and 33557-87,
Burton W. and Naomi R. Kanter. An order will be issued on the
Court’s own motion in docket No. 31301-87 striking respondent’s
assertion of increased income to the Kanters from IRA for the
1978 tax year. No such order will be issued in docket No. 33557-
87 because the transaction as to which respondent asserted
increased income is an issue the parties have identified as
Cablevision Programming Investments, which the parties have
settled.
 -24-

(3) whether commitment fees paid to Century Industries,

Ltd., during 1981 to 1984 and 1986 represent income earned by and

taxable to Kanter;

(4) whether Kanter received unreported income from Hi-

Chicago Trust during 1981 to 1983;

(5) whether Kanter is taxable on income attributed to the

Bea Ritch Trusts for 1986 and 1987;

(6) whether Kanter received unreported income from CMS

Investors Partnership for 1982 to 1984 and 1987 to 1989;

(7) whether Kanter received unreported income from Equitable

Leasing Co., Inc., during 1983;

(8) whether Kanter received unreported income for 1982

according to the bank deposits method of income reconstruction;

(9) whether Kanter received barter income from Principal

Services Accounting Corp. during 1988 and 1989;

(10) whether the Kanters received unreported interest income

during 1988;

(11) whether the Kanters are entitled to certain deductions

they claimed on Schedules A and C for 1986 to 1989;

(12) whether Kanter realized and must recognize capital

gains as a result of transactions involving Cashmere Investments

Associates, Inc., during 1983, and whether Kanter is entitled to

use the installment method for reporting purposes;
 -25-

(13) whether Kanter is entitled to research and development

and business expense deductions related to Immunological Research

Corp. for 1979;

(14) whether Kanter received unreported partnership income

during the taxable year 1978;

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

Associates for 1981;

(16) whether the Kanters are entitled to a loss from Equitec

for 1983 and 1984;

(17) whether the Kanters are entitled to an investment

interest expense deduction for 1981;

(18) whether the Kanters are entitled to an investment

credit carryover of $120,566 for 1978;

(19) whether the Kanters are entitled to an interest

deduction for 1986;

(20) whether the Kanters are entitled to a business

deduction of $104,231 for 1980;

(21) whether the Kanters are entitled to a deduction for a

charitable contribution to the Jewish United Fund for 1982;

(22) whether Kanter is liable for self-employment tax for

the taxable year 1982;

(23) whether the Kanters realized capital gains and losses

as reported on their tax return for 1987; and
 -26-

(24) whether Kanter is liable for various additions to tax

and increased interest for the years at issue.

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

In their responses to respondent’s objection to the STJ

report, petitioners assert that the Court should ignore

respondent’s objections to the extent respondent (1) failed to

make “specific, written objections” and merely rehashed proposed

findings of fact and legal arguments from respondent’s posttrial

briefs, and (2) proposed new findings of fact (not contained in

respondent’s posttrial briefs). In connection with the

foregoing, petitioners assert:

Also, in many of his objections, respondent block-
quotes directly from the now-tainted Stricken Opinion.
As this Court is well aware, the published opinion in
this case was found by the Supreme Court to be
violative of the Tax Court’s own rules and was stricken
from the record. Because the published opinion was the
result of a process that has been held by the Supreme
Court to be legally insufficient, it is manifestly
improper for respondent to base his objections upon
that opinion. Incredibly, however, respondent quotes
at length from the Stricken Opinion without
acknowledging that he is doing so. Also, in his
objections, respondent in many instances incorporates
his proposed findings which are extracted from the
Stricken Opinion and therefore legally insufficient.
As a result, this Court should not consider those
objections or proposed findings of fact. Moreover,
many of the findings from the Stricken Opinion have
already been directly criticized by the Fifth Circuit
in Estate of Lisle v. Commissioner, 341 F.3d 364 (5th
Cir. 2003).

We agree that new Rule 183(c) generally does not contemplate

that a party may propose new findings of fact in the party’s
 -27-

objection to a Special Trial Judge’s recommended findings of fact

and conclusions of law. Nevertheless, Rule 183(c) does not

provide a bar to new proposed findings of fact and leaves the

matter within the discretion of the reviewing Judge. Moreover, a

Judge who is assigned a case under new Rule 183 is obliged to

review a Special Trial Judge’s recommendations against the entire

record in the case and determine whether the recommended findings

of fact and conclusions of law merit adoption. In this regard,

new Rule 183(d) establishes a number of options that the

reviewing Judge normally may exercise during the review and

adoption process.16 Among these options, the reviewing Judge may

adopt, modify, or reject the Special Trial Judge’s

recommendations. Thus, the Court does not feel constrained from

correcting manifestly unreasonable findings of fact or making

additional findings of fact, so long as any additional facts find

direct support in the case record. With this understanding in

mind, we turn to the standard of deference to apply in reviewing

the recommended findings of fact and conclusions of law contained

in the STJ report.

16
Some of the options contemplated under new Rule 183(d),
such as receiving additional evidence or recommitting the
recommended findings of fact and conclusions of law with
instructions, are not available to the Court in these cases due
to limitations prescribed by the Courts of Appeals for the
Eleventh and Fifth Circuits when they remanded these cases.
 -28-

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

It is well settled that findings of fact and credibility

determinations made by the judicial officer who presided over the

trial of a case are presumed to be correct. Rule 183(d); Ballard

v. Commissioner, 544 U.S. 40 (2005) (and cases cited therein).

The axiom that deference must be given to the trial judge’s

findings of fact is rooted in the view that the trial judge (1)

is uniquely positioned to evaluate the credibility of witnesses,

(2) brings experience and expertise to the fact-finding process,

and (3) is normally the person most familiar with the record in a

case. Anderson v. City of Bessemer, N.C., 470 U.S. 564, 575, 580

(1985); see Fed. R. Civ. P. 52(a), Advisory Committee Notes (1985

amendment).

As previously discussed, the Courts of Appeals for the

Eleventh Circuit and the Fifth Circuit remanded the Ballard and

Lisle cases to this Court and directed that the recommended

findings of fact in the STJ report are presumed to be correct

“unless manifestly unreasonable”. Respondent concedes that,

although the Court of Appeals for the Seventh Circuit did not

articulate a particular standard for review in its remand of the

Kanter cases, the Court should apply the same “manifestly

unreasonable” standard in all of the cases consolidated herein.

Although respondent disagrees that the “manifestly unreasonable”

standard is the appropriate standard to be applied under new Rule
 -29-

183, we need not address the point in the context of these cases.

We proceed with the review of the STJ report mandated by the

Courts of Appeals and apply the “manifestly unreasonable”

standard of deference as more fully described in the caselaw

discussed below.

In Ballard v. Commissioner, 544 U.S. at 54-55, the Supreme

Court addressed the deference that is due a Special Trial Judge’s

recommended findings of fact under Rule 183 as follows:

Rule 183(c)’s origin confirms the clear
understanding, from the start, that deference is due to
factfindings made by the trial judge. Commenting in
1973 on then newly adopted Rule 182(d), the precursor
to Rule 183(c), the Tax Court observed that the Rule
was modeled on Rule 147(b) of the former Court of
Claims. Tax Ct. Rule 182 note, 60 T.C. 1150, (Tax
Court review procedures were to be “comparable” to
those used in the Court of Claims). Rule 182(d)’s
“[d]ue regard” and “presumed to be correct”
formulations were taken directly from that earlier
Rule, which the Court of Claims interpreted to require
respectful attention to the trial judge’s findings of
fact. See Hebah v. United States, 456 F.2d 696, 698
(Cl. Ct. 1972) (per curiam) (challenger must make a
“strong affirmative showing” to overcome the
presumption of correctness that attaches to trial judge
findings). The Tax Court’s acknowledgment of Court of
Claims Rule 147(b) as the model for its own Rule,
indeed the Tax Court's adoption of nearly identical
language, lead to the conclusion the Tax Court itself
expressed: Under the Rule formerly designated Rule
182(b), now designated 183(c), special trial judge
findings carry “special weight insofar as those
findings are determined by the opportunity to hear and
observe the witnesses.” Tax Ct. Rule 182 note, 60 T.C.
1150 (1973); see Stone v. Commissioner, 865 F.2d 342,
345 (CADC 1989). [Fn. ref. omitted.]

We briefly examine the Hebah and Stone cases cited by the

Supreme Court above.
 -30-

In Hebah v. United States, 197 Ct. Cl. 729, 456 F.2d 696,

698 (1972), the Court of Claims stated:

Under our rule, the [trial] commissioner’s findings of
fact are presumed to be correct because of his
opportunity to hear the witnesses and to determine the
weight to be accorded to their testimony. A party who
undertakes to overcome this presumption must make a
strong affirmative showing to the contrary. Wilson v.
United States, 151 Ct.Cl. 271 (1960) and Davis v.
United States, 164 Ct.Cl. 612 (1964).

Although the presumption does not extend to the
conclusions of law made by the trial commissioner, he
saw and heard the witnesses and had a much better
opportunity than the court to familiarize himself with
all of the circumstances involved. In the light of
this situation and a consideration of the record, we
find that under the peculiar facts and circumstances of
this case, his conclusions are not unreasonable or
unwarranted by the record. [Emphasis added.]

In Stone v. Commissioner, 865 F.2d 342 (D.C. Cir. 1989),

revg. Rosenbaum v. Commissioner, T.C. Memo. 1983-113, the Court

of Appeals for the District of Columbia Circuit addressed the

correct standard of deference to be applied by a Tax Court Judge

assigned to review a Special Trial Judge’s proposed findings of

fact under former Rule 182(d).17 In short, the Court of Appeals

rejected the proposition that a simple “preponderance of the

evidence” standard of review would suffice and instead held that

17
Former Rule 182(d), much like new Rule 183(d), provided
that “Due regard shall be given to the circumstance that the
commissioner had the opportunity to evaluate the credibility of
witnesses; and the findings of fact recommended by the
commissioner shall be presumed to be correct.” 60 T.C. 1150.
 -31-

a “clearly erroneous” standard of review should be applied in

such cases. Stone v. Commissioner, supra at 346-347.

Our understanding of the standard of deference to apply to

findings of fact and credibility determinations in the STJ report

is further informed by the Court of Appeals for the Eleventh

Circuit: “Credibility determinations are entitled to great

deference, and must not be disturbed unless manifestly

unreasonable.” Ballard v. Commissioner, 429 F.3d at 1031 (citing

Anderson v. City of Bessemer, N.C., supra at 575).

In Anderson, the Supreme Court granted certiorari to decide

whether a Court of Appeals correctly rejected the trial court’s

findings of fact in support of a judgment in favor of a plaintiff

in a sex discrimination case. The Supreme Court held the Court

of Appeals misapplied the “clearly erroneous” standard of review

governing a Court of Appeals’ review of a District Court’s

findings of fact as set forth in rule 52(a) of the Federal Rules

of Civil Procedure.18 Quoting United States v. United States

Gypsum Co., 333 U.S. 364, 395 (1948), the Supreme Court stated

that “‘[a] finding is “clearly erroneous” when although there is

evidence to support it, the reviewing court on the entire

evidence is left with the definite and firm conviction that a

18
Fed. R. Civ. P. 52(a) states in pertinent part:
“Findings of fact, whether based on oral or documentary evidence,
shall not be set aside unless clearly erroneous, and due regard
shall be given to the opportunity of the trial court to judge of
the credibility of the witnesses.”
 -32-

mistake has been committed.’” Anderson v. City of Bessemer,

N.C., 470 U.S. at 565. The Supreme Court embellished the

“clearly erroneous” standard of review as follows:

If the district court’s account of the evidence is
plausible in light of the record viewed in its
entirety, the court of appeals may not reverse it even
though convinced that had it been sitting as the trier
of fact, it would have weighed the evidence
differently. Where there are two permissible views of
the evidence, the factfinder’s choice between them
cannot be clearly erroneous. United States v. Yellow
Cab Co., 338 U.S. 338, 342 (1949); see also Inwood
Laboratories, Inc. v. Ives Laboratories, Inc., 456 U.S.
844 (1982).

This is so even when the district court’s findings
do not rest on credibility determinations, but are
based instead on physical or documentary evidence or
inferences from other facts. * * * [Id. at 573-574;
emphasis added.]

Although the phrase “manifestly unreasonable” does not

appear in the Anderson opinion, the Supreme Court did discuss the

“special deference” to be paid to a trial judge’s credibility

determinations. On this point, the Supreme Court stated:

When findings are based on determinations
regarding the credibility of witnesses, Rule 52(a)
demands even greater deference to the trial court’s
findings; for only the trial judge can be aware of the
variations in demeanor and tone of voice that bear so
heavily on the listener’s understanding of and belief
in what is said. See Wainwright v. Witt, 469 U.S. 412,
(1985). This is not to suggest that the trial judge
may insulate his findings from review by denominating
them credibility determinations, for factors other than
demeanor and inflection go into the decision whether or
not to believe a witness. Documents or objective
evidence may contradict the witness’ story; or the
story itself may be so internally inconsistent or
implausible on its face that a reasonable factfinder
would not credit it. Where such factors are present,
 -33-

the court of appeals may well find clear error even in
a finding purportedly based on a credibility
determination. See, e.g., United States v. United
States Gypsum Co., supra, [333 U.S.] at 396. But when
a trial judge’s finding is based on his decision to
credit the testimony of one of two or more witnesses,
each of whom has told a coherent and facially plausible
story that is not contradicted by extrinsic evidence,
that finding, if not internally inconsistent, can
virtually never be clear error. Cf. United States v.
Aluminum Co. of America, 148 F.2d 416, 433 (CA2 1945);
Orvis v. Higgins, supra, at 539-540. [Id. at 575-576;
emphasis added.]

Consistent with the foregoing, and in the light of the

Courts of Appeals’ directions to this Court on remand, we are

obliged to review the recommended findings of fact and

credibility determinations set forth in the STJ report under a

“manifestly unreasonable” standard of review, and we may reject

such findings of fact and credibility determinations only if,

after reviewing the record in its entirety, we conclude that the

recommended finding of fact or testimony (1) is internally

inconsistent or so implausible that a reasonable fact finder

would not believe it, or (2) is not credible because it is

directly contradicted by documentary or objective evidence. Id.

at 574-575; see Boyett v. Commissioner, 204 F.2d 205, 208 (5th

Cir. 1953) (a court may reject positive and uncontradicted

testimony as to a particular fact if the testimony “is inherently

improbable or manifestly unreasonable, even though no

contradictory testimony is offered” (emphasis added)), affg. a

Memorandum Opinion of this Court; Stone v. Commissioner, 865 F.2d
 -34-

at 346 (where the Court of Appeals for the D.C. Circuit discussed

Montgomery Coca-Cola Bottling Co. v. United States, 222 Ct. Cl.

356, 615 F.2d 1318 (1980), and concluded the case stands for the

proposition that “reversal of the initial fact-finder is proper

if the objective evidence overwhelms the initial fact-finder’s

inferences from testimony and demeanor”).

A final point on the subject of deference. In Ballard v.

Commissioner, 429 F.3d at 1031, the Court of Appeals for the

Eleventh Circuit stated that the Tax Court’s review and adoption

of a Special Trial Judge’s recommended findings of fact is

analogous to a District Court’s review of a magistrate judge’s

findings of fact, and, citing United States v. Cofield, 272 F.3d

1303, 1306 (11th Cir. 2001), it further stated that a magistrate

judge’s credibility determinations generally may not be rejected

without rehearing the disputed testimony. Kanter’s response to

respondent’s objections, filed under new Rule 183(c), includes an

argument that the Court of Appeals for the Eleventh Circuit made

it clear that this Court cannot reject the credibility

determinations set forth in the STJ report. We disagree. We do

not understand the Court of Appeals’ statement to mean that we

are barred from rejecting credibility determinations set forth in

the STJ report without first rehearing the disputed testimony.

Instead, the Court of Appeals observed that the deaths of primary

witnesses in these cases foreclosed retrial. Ballard v.
 -35-

Commissioner, 429 F.2d at 1032. Rather than treating the

credibility determinations as established on that account, the

Court of Appeals prescribed the standard under which they are to

be reviewed. Thus, we conclude we are not barred in these cases

from rejecting credibility determinations recommended in the STJ

report under the “manifestly unreasonable” standard of review

described above.

VI. Structure of the Court’s Report

After comparing the recommended findings of fact and legal

conclusions in the STJ report with the entire record in these

cases, and taking into account the parties’ posttrial briefs and

objections and responses filed pursuant to new Rule 183(c), we

have determined to reject some of the recommended findings of

fact in the STJ report because they are manifestly unreasonable

and to supplement others because they are incomplete.

In constructing the Findings of Fact portions of this

report, we have included many findings of fact drawn directly

from the STJ report, and we have made additional findings of fact

where necessary. For clarity, the findings of fact drawn

directly from the STJ report appear in italics and are

accompanied by page references to the STJ report.19 Footnotes

19
Some reordering and minor additions and changes have
been inserted in the recommended findings of fact adopted from
the STJ report. These minor changes did not alter the substance
of the adopted findings of fact and are not otherwise noted in
(continued...)
 -36-

taken from the STJ report likewise appear in italics but are

renumbered. In contrast, the Court’s additional findings of fact

appear in bold type accompanied by supporting citations of the

trial transcript, trial exhibit(s), and/or the parties’ original

posttrial briefs, as appropriate. Our departures from the

recommended findings of fact in the STJ report normally are

marked by a comment either in the text or in the margin

(including appropriate citations of the record). See Ballard v.

Commissioner, 429 F.3d at 1031. Any additions we have made in

the findings of fact portions of this report that do not

constitute findings of fact, such as headings and general

commentary, appear in normal type.

The Opinion portions of this report appear in normal type

and include (1) a summary of the legal analysis set forth in the

STJ report, (2) an evaluation of the credibility determinations

in the STJ report as weighed against the objective evidence drawn

from the entire record, and (3) a discussion and analysis of each

of the issues remaining in dispute.

19
(...continued)
the report.
 -37-

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

FINDINGS OF FACT (STJ report at 14)

With respect to the issues in dispute, the parties filed

several stipulations of facts.20 The facts reflected in these

stipulations, with the annexed exhibits, are so found and are

incorporated herein by reference.21

At the time the petitions were filed, the Kanters’ legal

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

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

residence was in the State of Texas. The independent coexecutors

of the Estates of Robert W. and Donna M. Lisle, Amy L. and Thomas

W. Lisle, were also legal residents of the State of Texas at the

time they were substituted as representatives of the Estates of

their deceased parents.

20
The STJ report does not contain any recommended findings
of fact regarding the examination process and related summons
enforcement proceedings that preceded the trial in these cases.
These matters are relevant to the question of whether Kanter and
Ballard are liable for additions to tax for fraud and are
addressed in detail in additional findings of fact, infra pp.
213-222.
21
Unless otherwise clear from the context, the following
words, their derivatives, and related terms are used for
narrative convenience only to describe the forms of the various
transactions in dispute in these cases: “invest”, “purchase”,
“borrow”, “pay”, “distribute”, “promise”, “loan”, “sale”, “note”,
“agreement”, “obligation”, “interest”, “capital contribution”,
“paid-in capital”, “officer”, “director”, “shareholder”, and
“partner”. By our use of such terms, we do not mean to suggest
any conclusions concerning the actual substance or
characterization of the transactions for tax purposes.
 -38-

I. Petitioners22

A. Burton W. Kanter (STJ report at 18-20)

Petitioner Burton W. Kanter is an attorney who has

continuously been engaged in the practice of law at 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. From

1954 to 1956, he was an attorney-adviser with the U.S. Tax Court

at Washington, D.C. Since 1956, his law practice has been at

Chicago, Illinois. His primary expertise is in Federal income

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

partner in the law firm Levenfeld & Kanter, which later became

Levenfeld, Kanter, Baskes & Lippitz. That firm dissolved in

1981, and Kanter thereafter practiced with the firm of Kanter &

Eisenberg. As of the time of trial, Kanter was serving in an “of

counsel” capacity with the Chicago firm of Neal, Gerber &

Eisenberg.

At the time of trial and for the past 10 years, Kanter

taught courses in estate and gift taxation and estate planning at

22
The STJ report, at 15, opened with recommended findings
of fact concerning Investment Research Associates, Ltd. (IRA).
This report begins with findings of fact concerning the
backgrounds of Kanter, Ballard, and Lisle, followed by findings
of fact concerning IRA and other entities that Kanter employed in
the transactions in dispute (hereinafter sometimes referred to as
Kanter-related entities).
 -39-

the University of Chicago Law School. Kanter has lectured and

written extensively in the area of Federal tax law. He has also

been an active participant in professional bar associations. For

a number of years, Kanter has been a writer and contributor to

the Journal of Taxation, a national monthly publication devoted

exclusively to Federal taxation. One of the popular features of

this publication is the Shop Talk section, which was originated

and edited by Kanter. At the time of trial, Kanter was a senior

editor with the Journal of Taxation. Kanter is generally

recognized as renowned in his field. All of this has resulted in

a successful and prolific law practice, which has led to Kanter’s

not only being engaged in the practice of law but also to his

being extensively involved in consultation, development, and

investments in a number of various business fields and

enterprises.

Commensurate with his reputation as a highly successful and

skillful tax lawyer, Kanter, over the years, has amassed an

impressive array of business and professional clients and

contacts in business and industry throughout the United States.

For instance, Kanter has performed extensive legal work for the

Pritzker family, majority owners of the Hyatt Corp., a major

hotel company in the United States. He is and was a good friend

of certain of the Pritzker family members, including the late

A.N. Pritzker, the head of the Pritzker family, whom Kanter
 -40-

personally represented. Kanter also served as a director on

several corporate and charitable organization boards.

Kanter has made many investments through numerous entities,

including corporations, partnerships, and family trusts. Some of

these family trusts are trusts the income of which is taxable to

Kanter pursuant to the grantor trust provisions of sections 671

through 678. A number of Kanter’s family trusts own substantial

stock interests in The Holding Co., Inc., a corporation that made

extensive investments during the years at issue.

Additionally, on occasion, Kanter and/or entities associated

with him have entered into certain arrangements with various

individuals, pursuant to which Kanter would use his business and

professional contacts to assist such individuals either in

obtaining potential business opportunities or in raising capital

for business ventures. In exchange for such assistance from

Kanter, these individuals agreed to share their profits or fees

payable to an entity or entities associated with Kanter.23

23
The STJ report incorrectly stated that entities Kanter
represented provided assistance to various individuals in
obtaining business opportunities or in raising capital. As
discussed in detail in the Court’s additional findings of fact,
infra pp. 51, n. 27 (Weisgal testimony), 91-107 (Frey), 107-124
(Schaffel), 124-131 (Schnitzer), and 131-152 (Eulich), there is
no evidence (1) anyone at any Kanter-related entity provided the
businessmen involved in the transactions in dispute (sometimes
referred to as The Five) with assistance in obtaining business
opportunities or in raising capital, or (2) any of these
businessmen were relying on anyone other than Kanter, in his
(continued...)
 -41-

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

in any of the activities giving rise to this litigation. She is

a petitioner in these proceedings solely because she filed joint

Federal income tax returns with Kanter for the years at issue.

After paying a small amount of tax in 1978, Kanter paid no

Federal income taxes during 1979 through 1989.24 Kanter filed

Federal income tax returns that reported adjusted gross income

and income tax as follows:

Adjusted Gross Income
Year Income (Loss) Tax Paid Exhibit

1978 ($44,386) $1,671 120
1979 (105,084) -0- 121
1980 (155,026) -0- 123
1981 (53,614) -0- 125
1982 (287,536) -0- 127
1983 (819,449) -0- 128
1984 (804,482) -0- 130
1985 (954,695) -0- 130A
1986 (1,529,213) -0- 131
1987 (2,004,257) -0- 132
1988 (1,340,459) -0- 133
1989 (1,331,576) -0- 134

B. Claude M. Ballard (STJ report at 20-22)

Ballard was an employee of Prudential. He began his

employment with Prudential in 1948 in its real estate department.

23
(...continued)
individual capacity, to assist them in obtaining business
opportunities and/or in raising capital.
24
Kanter paid small amounts of self-employment tax. Exh.
120.
 -42-

He worked continuously at Prudential until his retirement in

early 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 an individual

named Donald Knab who was in charge of all of Prudential’s real

estate operations. After leaving Prudential, Ballard became a

general partner with Goldman Sachs, a brokerage and/or an

investment firm in New York City. Later, he became a limited

partner with Goldman Sachs.

Essentially, Ballard’s work with Prudential, in its real

estate equity operations, involved the purchase and sale of

existing properties, as well as the development of new

properties. It included, additionally, the management of such

properties, including the negotiation and sale of properties,

where warranted. Ballard supervised the staff of this department

at Prudential’s headquarters, as well as the real estate

department staff at Prudential’s regional offices throughout the

United States.
 -43-

In his position with Prudential, Ballard met and was in

contact with attorneys, developers, businessmen, and contractors

involved in or affected by Prudential’s acquisition and/or

development, maintenance, operation, and financing activities.

Ballard first met Kanter sometime in 1972 at Houston, Texas, in

connection with the opening of the Houston Hyatt Hotel. As

indicated previously, Kanter represented the Pritzker family, the

majority shareholder/owners of Hyatt Corp. At the Houston Hyatt

Hotel’s opening, Ballard was introduced to Kanter by A.N.

Pritzker (the head of the Pritzker family), who told Ballard that

Kanter was A.N. Pritzker’s “everything”. In the succeeding

years, Kanter and Ballard had numerous business and professional

contacts with each other.

Petitioner Mary B. Ballard, Ballard’s wife, was not

involved, except in a very limited way, in any of the activities

giving rise to this litigation. She is a petitioner in these

proceedings solely because she filed joint Federal income tax

returns with Ballard for the years at issue.

C. Robert W. Lisle (STJ report at 22-23)

Lisle was also an employee of Prudential from September 1950

to April 1982. He was also employed in the real estate

department at Prudential, in real estate development and in
 -44-

mortgage financing. The development aspect of his work was

conducted under the umbrella of a subsidiary corporation of

Prudential, which was known as PIC Realty Corp. (PIC Realty).

Lisle was president of PIC Realty. 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. To a large

extent, the career of Lisle paralleled that of Ballard. Lisle

also 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. At the time Lisle left

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

Lisle’s supervisor at Prudential was also Donald Knab. After

leaving Prudential in April 1982, Lisle worked for The Travelers

Insurance Co. (Travelers) until April 1988, doing virtually the

same kind of work he had done for Prudential.

Lisle met Kanter sometime between 1968 and 1970. The two

had numerous contacts with each other in succeeding years,

including the period after Lisle left Prudential and worked for

Travelers. The record does not reflect what outside business

activity Lisle was involved with that would be relevant to these

cases between the time Lisle left Travelers in April 1988 until

his death in 1993.
 -45-

Donna M. Lisle, Lisle’s wife, was not involved in any of the

activities giving rise to this litigation, and her estate is a

party to these proceedings solely by virtue of Mrs. Lisle’s

having filed joint Federal income tax returns with Lisle for the

years at issue. She died in 1993.

D. Additional Findings of Fact Regarding Ballard and Lisle

Donald Knab (Knab) worked with Ballard and Lisle in

Prudential’s Houston regional office in the late 1960s and, after

being reassigned to Prudential’s corporate headquarters in Newark

in the early 1970s, Knab asked Ballard and Lisle to come to work

for him in the real estate investment department. Knab, Transcr.

at 602-604. Knab had very high regard for Ballard’s and Lisle’s

abilities. Knab, Transcr. at 608.

1. Ballard

Ballard considered it common in the real estate business for

intermediaries to introduce brokers to corporate real estate

owners and financiers, such as Prudential, and for such

intermediaries and brokers to share any fees arising from real

estate transactions related to such introductions. Ballard,

Transcr. at 215-216.

Ballard’s high-ranking-executive position at Prudential

allowed him to exert significant influence over Prudential’s real

estate investment decisions, including awards of property
 -46-

management contracts, financing transactions, and related

business. Ballard, Transcr. at 215; Knab, Transcr. at 606-609;

Strum, Transcr. at 511, 521-522. Ballard believed that his power

to reject or veto a proposed transaction was the most significant

power that he wielded at Prudential. Ballard, Transcr. at 215.

2. Lisle25

Lisle became president of PIC Realty in 1970. Exh. 2030, at

2. Lisle was first introduced to Kanter by A.N. Pritzker during

the period 1968 to 1970. Id. at 10-11. At that time, PIC Realty

was involved in the construction of what would become the Houston

Hyatt Hotel, and Kanter was representing the Pritzkers. Ballard,

Transcr. at 119-120; Exh. 2030, at 11.

Lisle was authorized at both Prudential and Travelers to

commit up to $20 million to real estate financing transactions

and development projects. Exh. 2030, at 2, 9-10. Lisle’s

position at Travelers, senior vice president for the real estate

investment department, was higher than his position at

Prudential. Id. at 9. Lisle’s high-ranking-executive positions

at Prudential and Travelers allowed him to exert significant

influence over Prudential’s and Travelers’ real estate investment

25
As previously indicated, Lisle died before the trial was
held in these cases. Exh. 2030 is a transcript of an interview
that IRS agents conducted with Lisle on Jan. 10, 1990.
 -47-

decisions, including awards of construction contracts, financing

transactions, development projects, and related business.

Ballard, Transcr. at 215; Strum, Transcr. at 511, 521-522; Knab,

Transcr. at 606-609.

E. Kanter-Related Entities

1. Investment Research Associates, Ltd. (IRA) (STJ report
at 15-17)

IRA was incorporated as a subchapter C corporation in the

State of Delaware on August 26, 1974, originally under the name

Cedilla Co. In the annual franchise tax report for IRA filed

with the State of Delaware, dated March 1, 1979, the name of

Cedilla Co. was changed to Investment Research Associates, Ltd.

To avoid confusion, we refer to the corporation at all times as

IRA.

IRA consistently filed annual franchise tax reports with the

State of Delaware. Between 1974 and 1977, IRA was authorized to

issue both common stock and several classes of preferred stock.

Exhs. 4, 9071. IRA’s annual franchise reports filed with the

State of Delaware from 1975 to 1988 often were not accurate in

reporting the shares of its stock that were issued and

outstanding. Exhs. 4, 9071.

IRA has always had a board of directors and a full slate of

officers. It has consistently filed Federal income tax returns.
 -48-

During 1977 through 1989, IRA reported consolidated total

income, taxable income/losses, and net operating losses as set

forth in the following table:

Table 1

Year Total Income Taxable Income (Loss) Net Operating Losses

1977 $234,790 ($271,394) ($7,954)
1978 1,004,475 (18,673) (271,394)
1979 1,944,332 406,771 (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 (425,538) (121,501)
1984 3,606,785 (175,946) (89,235)
1985 3,118,893 96,363 (175,946)
1986 2,345,762 (327,854) --
1987 299,794 (16,942) (111,843)
1988 (526,393) (637,842) (10,550)
1989 1,011,577 (116,521) (1,057,468)

Exhs. 10 to 24, 9668, 9669. IRA paid tax of $94,618 for the

taxable year 1979. Exh. 10.

a. IRA’s Shareholders

Before October 28, 1975, Delores Keating (Keating), a real

estate broker, held 1,000 shares of IRA’s common stock. Exh.

9051. In 1973 or 1974, Mildred Schott (Schott) began working

with Keating. Schott, Transcr. at 2122-2123. Schott previously

worked as a legal secretary and had a real estate brokerage

license. She was introduced to Kanter by a mutual acquaintance

of theirs.
 -49-

On October 28, 1975, Keating’s 1,000 shares of IRA common

stock were exchanged for 500 shares of class B preferred stock.

Exh. 9051. Although she did not recall the fact, Schott held

1,200 shares of IRA class A preferred stock until 1982. Schott,

Transcr. at 2113, 2129; Exhs. 10, 12, 14, 17. Schott held IRA

stock to enable the company to hold a corporate real estate

license. Schott, Transcr. at 2119; Exh. 4022.

On October 28, 1978, IRA issued 1,000 shares of common stock

in equal shares to 25 trusts known collectively as the Bea Ritch

Trusts. Exh. 9051; Exh. 135, at 23. By 1978, IRA redeemed

Keating’s 500 shares of class B preferred stock. Exh. 4.

During the examination of IRA’s returns, an IRS agent

recalled being presented with IRA corporate minutes for 1983

which indicated that IRA’s shareholders at the time included the

Bea Ritch Trusts, Schott, a Ballard family trust, and a Lisle

family trust. Batory, Transcr. at 3151-3152.

b. The Bea Ritch Trusts

The Bea Ritch Trusts were established in 1969 and were named

after Beatrice K. Ritch, Kanter’s mother. After 1982, IRA had

only common stock outstanding, and the Bea Ritch Trusts were

IRA’s sole shareholders.

Originally, when the 25 Bea Ritch Trusts were established in

1969, the beneficiaries of the Bea Ritch Trusts were Kanter,
 -50-

Kanter’s family, and other relatives of Kanter. By about 1977,

Kanter had purportedly renounced all of his interest as a

beneficiary in the Bea Ritch Trusts.26 Solomon Weisgal

(Weisgal), an accountant and a longtime friend and business

associate of Kanter, has been the sole trustee of the Bea Ritch

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

has an extremely broad power either to accumulate the Bea Ritch

Trusts’ income or to distribute (i.e., sprinkle) the trusts’

income and assets among all or any of the trusts’ beneficiaries

in virtually any manner he deemed appropriate.

c. IRA’s Officers and Directors

Before October 27, 1975, Keating was IRA’s president and

secretary. Exh. 9050. On October 27, 1975, Keating resigned as

IRA’s president. Id.

On October 27, 1975, Schott was elected IRA’s president,

and Sharon Meyers (Meyers) was elected IRA’s secretary. Id.

Meyers had originally worked as Kanter’s secretary. Meyers,

26
Whether Kanter’s alleged renunciations were shams is a
factual question raised infra Issue V. In any event, numerous
additional trusts were later added as beneficiaries to the Bea
Ritch Trusts. Exhs. 135, 9187, 9269, 9270, 9271. See app. 17 to
this report. Additional trusts (and groups of trusts) for the
benefit of Kanter’s family members included the Everglades Trusts
(5), the T.C. Family Trust, the Egandale-Vine Trust, the Beach
Trust, the Baroque Trusts (3), the Softy Trusts (10), the
Pillpoppers Trusts (3), and the Chamber Trusts (3). Exhs. 9213-
9220.
 -51-

Transcr. at 2890-2891. By the 1970s, Meyers’s position at

Kanter’s law firm evolved to that of Kanter’s administrative

assistant. Meyers, Transcr. at 2894-2899. Meyers served as an

officer and/or director of IRA at various times. Exh. 4.

From 1975 to 1980, Schott remained the president of IRA and

Weisgal was vice president.27 From 1980 to 1989, the president

of IRA was Lawrence Freeman (Freeman), an attorney in Miami,

Florida, and a friend and business associate of Kanter. Although

Freeman was not paid for serving as IRA’s president, Freeman and

his law firm received significant legal business by referrals

from Kanter. Although Freeman was IRA’s president and director

for most of the 1980s, he characterized his role as primarily

that of a bookkeeper/accountant and administrator. Freeman,

Transcr. at 1819.

In 1989, Kanter became IRA’s acting president. Until 1989,

Kanter had never been an officer or employee of IRA. Exhs. 4,

27
Solomon Weisgal (Weisgal) had little recall regarding
his activities as either an officer or a director of IRA or The
Holding Co. (THC). Weisgal, Transcr. at 434-437, 443, 445, 458-
460. Weisgal believed the Bea Ritch Trusts were IRA’s sole
shareholders from its original organization through 1989.
Weisgal, Transcr. at 440. Weisgal had no recollection of the
person or persons at IRA or THC who would have generated business
opportunities for The Five or the persons at IRA or THC who would
have performed services for The Five under various agreements
that he executed on behalf of IRA or THC during the years at
issue. Weisgal, Transcr. at 444-446 (Schaffel), 462 (Essex).
 -52-

9071, 9085. Kanter and his law firm provided legal services to

IRA. Gallenberger, Transcr. at 1990.

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

(Grogan) served as IRA’s directors. Exh. 4. Grogan was an

accountant who began working at Kanter’s law firm in the mid-

1970s. Grogan, Transcr. at 1395-1396. From 1981 through 1989,

Freeman served as IRA’s director. Exhs. 4, 9071.

Ballard and Lisle were never shareholders, officers,

directors, or employees of IRA. Exh. 4. However, in December

1981, IRA issued a check to Ballard in the amount of $12,500–-an

amount identified in the memo section of the check as a

director’s fee. Exh. 3007. Ballard cashed the check, and IRA

deducted the payment as a director’s fee on its 1981 tax return.

Id.; Ballard, Transcr. at 218; Exhs. 14, 9071.

d. IRA’s 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 (Zeus),28 Carlco, Inc. (Carlco), TMT, Inc. (TMT), and

BWK, Inc. (BWK). Carlco, TMT, and BWK are discussed in

28
Zeus Ventures (Zeus), is discussed with regard to the
Frey transactions described infra pp. 91-107.
 -53-

substantial detail below. IRA also, at one point, owned a

majority stock interest in International Films, Inc.

e. IRA’s Business Activities

IRA’s principal activity was making investments, either for

itself or through its subsidiaries. It maintained bank accounts

and books and records of its activities. In connection with its

investment activities, IRA utilized the services of its officers,

employees, advisers, and consultants, among whom was Kanter.

IRA was primarily a vehicle for holding passive investments

and generally had no paid employees. Meyers, Transcr. at 2911-

2912; Petitioners’ Reply Brief at 66. During the period 1983 to

1989, IRA did not claim any deductions for salaries, wages, or

compensation paid to its officers. Exhs. 18-24.

2. Carlco, Inc., TMT, Inc., and BWK, Inc. (STJ report at
17-18)

Kanter was a beneficiary of a trust called the Morkan Trust

No. 1.29 Exh. 56. On October 17, 1983, Kanter exercised a

limited power of appointment under the Morkan Trust No. 1 and

directed the trustee, Roger Baskes,30 to transfer $2,500 to each

of two newly formed trusts: Christie Trust and Orient Trust.

29
Morkan Trust No. 1 was named after Kanter’s father,
Morris Kanter. Exh. 56.
30
Roger Baskes was a lawyer employed at one time at
Kanter’s law firm. Baskes, Transcr. at 542-543.
 -54-

Exhs. 56, 79. Meyers was named trustee of the Christie and

Orient trusts. Id. 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. Id.

Carlco, TMT, and BWK were so-called shelf corporations that

Kanter first incorporated in 1982 but remained dormant until late

1983. Kanter, Transcr. at 3604-3605. In December 1983, IRA

acquired 1,000 shares or 100 percent of the common stock of each

of Carlco, TMT, and BWK. Exh. 18, at 7. IRA paid $6,000 to each

of the corporations for the shares of stock. Exhs. 68, 92, 113.

In December 1983 and January 1984, Carlco, TMT, and BWK each

issued preferred shares of stock. Carlco preferred shares were

issued to the Christie Trust (Lisle’s family trust); TMT

preferred shares were issued to the Orient Trust (Ballard’s

family trust); and BWK preferred shares were issued to the BK

Children’s Trust (one of the Bea Ritch Trusts). As a result of

those trusts’ ownership of these preferred shares, Carlco, TMT,

and BWK no longer qualified to be members of IRA’s consolidated

group of corporations for tax purposes and were not included in

the consolidated returns IRA filed. For 1984 and thereafter,

Carlco, TMT, and BWK, each filed separate Federal corporate

income tax returns. The record does not include a complete set
 -55-

of Carlco’s, TMT’s, or BWK’s corporate minutes books, stock

ledgers, or stock registers after 1984.

During this period, Kanter recommended and proposed to

Freeman (IRA’s president) and Weisgal (trustee of the Bea Ritch

Trusts, which held 100 percent of IRA’s common stock) that

generally Carlco and TMT should each receive a 45-percent share

of IRA’s available investment funds and that BWK should receive

the remaining 10 percent of IRA’s available investment funds.

Kanter testified that the distribution of IRA’s funds to

Carlco, TMT, and BWK in a 45/45/10 percent split represented (1)

a “free-cashflow asset allocation” he and Freeman devised, and

(2) an effort to diversify IRA’s investments. Kanter, Transcr.

at 3663-3666, 3690-3691, 3694-3695. The diversification of

investments was to be achieved by having Lisle manage Carlco and

invest principally in municipal bonds, Ballard manage TMT and

invest principally in real estate, and Kanter manage BWK and make

miscellaneous investments. Id.; Ballard, Transcr. at 222.31

Kanter, in fact, did not have time to manage BWK’s investments.

Kanter, Transcr. at 3695.

31
As shown in additional findings of fact regarding the
flow of funds, see infra pp. 162, 187-188: (1) IRA did not
allocate all of its free cashflow to Carlco, TMT, and BWK during
the period in question, and (2) in addition to real estate
investments, Ballard invested substantial amounts of TMT’s funds
in cash and municipal bonds.
 -56-

Kanter also testified that he recommended Carlco, TMT, and

BWK be removed from IRA’s consolidated group for tax-reporting

purposes because (1) he was concerned that Carlco’s earnings from

tax-exempt municipal bonds might imperil IRA’s interest

deductions, and (2) he wanted to shelter Ballard and Lisle from

“second-guessing” by Freeman or another IRA officer.

Kanter, Transcr. at 3685-3686.32 Pursuant to Kanter’s proposal,

from 1984 through 1989, IRA transferred substantial funds and

other assets to Carlco, TMT, and BWK in the respective

45-percent, 45-percent, 10-percent allocation. From 1984 through

1992, Ballard managed TMT’s investments, and Lisle managed

Carlco’s investments.

3. Additional Findings of Fact Regarding The Holding Co.

Other than identifying The Holding Co. (THC) as a Kanter-

related entity that held investments, the STJ report did not

include any detailed findings of fact regarding the organization

and operation of THC. Inasmuch as THC and its subsidiaries

received some of the disputed payments from The Five, and THC is

32
Kanter did not explain how removing Carlco and TMT from
IRA’s consolidated group of corporations for tax reporting
purposes would serve to shelter Ballard and Lisle from second-
guessing by an officer of IRA, given that IRA purportedly
continued to own all of Carlco’s and TMT’s common stock and
Carlco and TMT remained IRA’s “legally controlled” subsidiaries.
See Petitioners’ Reply Brief at 3.
 -57-

discussed in the flow-of-funds analysis below, additional

findings of fact are warranted.33

THC was incorporated as a subchapter C corporation on

December 8, 1976. Exh. 153. THC owned several subsidiary

corporations including the Citra Co., Active Business Corp.,

Zion Ventures, Inc.,34 Harbor Exchange Lending Operation (HELO),35

LBG Properties, Inc., The Nominee Corp., Oil Investments, Ltd.,

and Tanglewood Properties, Inc. Exhs. 153, 154, 156-160.

THC held numerous partnership interests during the period in

question. Id.

a. THC’s Shareholders, Officers, and Directors

The shareholders statement on each of THC’s tax returns

shows that Kanter owned THC’s voting stock as follows: 1977--75

percent; 1978--76 percent; 1979--76 percent; 1980--76 percent;

1983 to 1986--not more than 50 percent.36 Exh. 153, at 25; Exh.

154, at 14, l. 10; Exh. 156, at 13, l. 10; Exhs. 157-160. THC’s

shareholders between 1981 and 1983 included Kanter, his immediate

33
Payments THC received from The Five (in this case
Schaffel, Frey, and Eulich) are summarized infra pp. 207-208.
34
Zion Ventures, Inc. (Zion), is discussed with regard to
the Frey transactions described infra pp. 91-107.
35
Harbor Exchange Lending Operation (HELO) is discussed
with regard to the flow-of-funds analysis infra pp. 196-205.
36
The record does not include a complete set of THC’s
corporate minutes books, stock ledgers, or stock registers.
 -58-

family members, and a large number of Kanter family trusts. Exh.

152, at 1, 2, 6, 7; Exh. 454.

Kanter did not report on his tax returns any sales of THC

stock during the years at issue. Exhs. 120-134.

During 1981 to 1983, THC’s officers and directors included

Kanter, Weisgal, Meyers, Gallenberger, and Joshua Kanter. Exh.

152.

b. THC’s Tax Returns

THC filed consolidated Federal income tax returns (and

amended returns) reporting taxable income or losses for the years

and in the amounts as follows:

TYE
Aug. 31 Losses

1978 ($132,095)
1979 (973,792) [amd.]
1980 38,351
1981 –-
1982 –-
1983 –-
1984 (7,552,865)
1985 (5,930,863)
1986 (5,652,815)
1987 (6,166,172)

Exhs. 153-160. THC’s tax returns for 1981 to 1983 are not

part of the record.
 -59-

4. The Administration Co., Inc., and Principal Services
Accounting Corp. (STJ report at 28-32)

The Kanter-related entities described above, particularly

IRA and THC, required a clerical staff to assist in bookkeeping

and ministerial tasks. Meyers, Transcr. at 2890-2892; Grogan,

Transcr. at 1396-1397, 1410. During the mid-1970s to early

1980s, these ministerial tasks were performed by clerical

assistants and bookkeepers, such as Meyers and Grogan, who were

employees of Kanter’s law firm (Levenfeld & Kanter) but who

worked for Kanter nearly full time. Id.

By 1981, bookkeeping for IRA, THC, and other Kanter-related

entities had become so voluminous that The Administration Co.,

Inc. (TACI), was organized for that purpose. Meyers, Transcr. at

2901, 2908-2909.37 TACI was incorporated in the State of

Delaware on September 21, 1981, and was authorized to do business

in the State of Illinois. Its articles of incorporation stated

that it was “to engage in any lawful act or activity for which

corporations may be organized under the General Corporation Law

of Delaware.” In TACI’s application to do business in the State

of Illinois, a more comprehensive statement of TACI’s purpose was

37
The Administration Co., Inc. (TACI) 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.
 -60-

that the corporation would engage in consultant and advisory

work, including investment, management, and advisory services.

On the date TACI was incorporated, Weisgal, as trustee of the

Pyramid Trust, subscribed to the total number of shares

authorized to be issued by the corporation. Sharon Meyers was

the Pyramid Trust’s sole beneficiary. Sharon Meyers was the sole

director of TACI and was its initial president and treasurer from

1981 through 1985.

TACI was organized to assist its clients in their financial

and investment activities. TACI’s clients included individuals,

corporations, partnerships, trusts, various clients of Kanter,

and members of his law firm. However, not all of the clients of

TACI were clients of Kanter’s law firm. At various times, TACI

had hundreds of clients, including Kanter, IRA, and

THC. From 1981 through 1988, TACI had between 200 to 500

clients.

TACI had several employees at any given time, mostly

clerical assistants, bookkeepers, and accountants. TACI received

moneys for and on behalf of clients and paid out moneys

either to clients or to third parties on behalf of clients. TACI

maintained books and records for each of these clients and, in

many instances, prepared clients’ tax returns. TACI charged a

fee for its services.
 -61-

With respect to moneys TACI collected and held for its

clients, instead of having a separate bank account for each

client, at the suggestion of the bank where TACI did business,

a single bank account was opened, in TACI’s name, which served as

a common depository fund for all of TACI’s clients. That account

was known as the TACI Special E Account.38 TACI’s books and

records reflected each client’s balance of money in the account

and also reflected the deposits or withdrawals by each client

affecting that client’s balance in the account. TACI also

maintained at its bank another similar account known as the TACI

Special Account, which was also for the benefit of TACI’s

clients. This account was not used as an operating account for

TACI’s clients but rather was used to pool or aggregate idle

funds of TACI’s clients. The moneys in this account were

utilized generally to buy certificates of deposit because a

higher rate of return could be realized for TACI’s clients

through aggregating their funds to purchase larger-denomination

certificates of deposit. Funds from this account were also lent

to other TACI clients. Deposits to and withdrawals from the TACI

Special E Account and the TACI Special Account were posted to the

38
The bank insisted that TACI have a single bank account,
as opposed to hundreds of bank accounts for separate clients,
because this saved the bank considerable administrative expenses.
During this period, the bank did not charge account holders
banking fees either for checks deposited to their accounts or for
checks written on their accounts.
 -62-

appropriate client accounts. TACI issued annual tax statements

and reports to its clients and the Internal Revenue Service on

the interest income earned by each client on that client’s funds

in the TACI Special E Account and the TACI Special Account.

Kanter, as a client of TACI, had funds of his own in both

the TACI Special E Account and the TACI Special Account. TACI,

as part of its services and acting on Kanter’s behalf, paid some

of Kanter’s business and personal expenses out of Kanter’s funds

in these accounts. All checks issued by TACI on behalf of a

client were debited against the balance such client had in the

accounts. If a client had a negative balance in the accounts,

that debit amount was considered an indebtedness by the client to

TACI. Any positive balance a client had in the accounts was

considered money belonging and owed to said client.

Included among the services provided by TACI were

bookkeeping services for its clients. This included keeping

books and records for clients and the preparation of individual

income tax returns. TACI prepared Kanter’s income tax returns

for all or some of the years at issue.

TACI’s offices were located either at the law firm offices

of Kanter or in close proximity thereto.

Meyers, who was president of TACI, directed the staff and

employees of TACI until 1985. Linda Gallenberger (Gallenberger),

a C.P.A., became vice president of TACI in 1982 and worked under
 -63-

the direction of Meyers. When Meyers left TACI, Kanter briefly

served as acting president of TACI and, thereafter, Gallenberger

became TACI’s president from 1985 through 1988.

TACI employed several other clerical assistants,

bookkeepers, and accountants, including Lisa Klopman Shanker

(Shanker, Transcr. at 998), Sharon Bayers (Bayers, Transcr. at

1005-1006), Rosemary Snedden (Bayers, Transcr. at 1010), Rosaline

Weiss (Weiss, Transcr. at 796), Phyllis Dassinger (Dassinger,

Transcr. at 629-630), and Kim Moxely Roehn (Roehn, Transcr. at

967-968).

Kanter sometimes instructed Meyers, Gallenberger, and other

TACI staff on how a particular transaction should be recorded,

where a particular check should be deposited, or to whom moneys

should be paid. Meyers, Transcr. at 2900, 2911 2934;

Gallenberger, Transcr. at 1939, 1957.

Grogan maintained the books and records and prepared tax

returns for IRA and THC. Grogan, Transcr. at 1400-1403, 1415-

1417, 1476. Grogan also prepared Kanter’s tax returns. Grogan,

Transcr. at 1479-1480. Kanter instructed Grogan on how THC’s

assets were to be invested and how the tax returns for IRA and

THC should be prepared. Grogan, Transcr. at 1421, 1479-1480.
 -64-

TACI filed for bankruptcy in February 1988.39 Lawrence

Korrub served as TACI’s bankruptcy attorney. Korrub, Transcr. at

1805. During TACI’s 1988 bankruptcy proceedings, the records

that TACI maintained for Kanter and Kanter-related entities were

not turned over to Korrub. Korrub, Transcr. at 1807-1808. The

only documents that Korrub received were copies of TACI’s tax

returns. Id. During TACI’s bankruptcy, Gallenberger sent TACI’s

books and records, including the bank statements and canceled

checks related to the TACI Special E and TACI Special Accounts,

to Kanter. Gallenberger, Transcr. at 1970-1973.

At the time of TACI’s bankruptcy, a new corporation,

Principal Services Accounting Corp. (PSAC), was organized. All

of PSAC’s outstanding shares of stock were initially owned by ARO

Trust, of which trust Kanter was the trustee. In 1989,

Gallenberger became the president of PSAC. Gallenberger,

Transcr. at 1978-1980. In 1990, Linda Gallenberger purchased

from ARO Trust all of PSAC’s shares for $100 and her assumption

of PSAC’s outstanding debts, which totaled over $100,000.

Prior to TACI’s filing for bankruptcy, PSAC took over a

number of TACI’s clients, including Kanter, IRA, and THC. PSAC

39
The STJ report, at 32 n.14, incorrectly stated that the
record was not clear as to why TACI went bankrupt. TACI filed
for bankruptcy after the Internal Revenue Service (IRS) assessed
a number of tax return preparer penalties against the firm for
various infractions. Gallenberger, Transcr. at 1973-1974.
 -65-

performed services for clients similar to those which TACI had

provided to TACI’s clients. For a short period in 1989, PSAC

also established two accounts similar to the TACI Special E

Account and the TACI Special Account.

The fees PSAC received from its clients were not sufficient

to fund PSAC’s operations. From the time PSAC came into

existence in 1989 until the time Gallenberger purchased the stock

of PSAC from the ARO Trust in 1990, PSAC borrowed over $100,000

from BWK and THC to pay its employees’ salaries. Gallenberger,

Transcr. at 1980-1982, 1987, 2041. BWK lent the money to PSAC

either directly or through the TACI Special E Account.

Gallenberger, Transcr. at 1983-1984.

Beyond 1990, PSAC did not generate enough fees to cover its

operational costs, continued to operate at a loss, and borrowed

money from BWK. Gallenberger, Transcr. at 1985-1986. At the

time the record in these cases was closed, PSAC had not repaid

the loans from BWK. Id. When borrowing money, Gallenberger

either contacted Kanter about the loan or went ahead and borrowed

the money herself. Gallenberger, Transcr. at 1986-1987.

PSAC’s bookkeeping procedures and return preparation

procedures were essentially the same as TACI’s. Gallenberger,

Transcr. at 1988-1989, 2078. Any questions that Gallenberger had
 -66-

regarding accounting matters were answered by Kanter or Freeman.

Id.

PSAC was located at Kanter’s law firm, Neal, Gerber &

Eisenberg. George, Transcr. at 1282-1283. PSAC moved

simultaneously with Kanter’s law firm. George, Transcr. at 1283-

1284.

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

A. The STJ Report

A certain group of persons and/or entities has been referred

to by the parties collectively as “The Five”. The Five, for the

most part, play a prominent role in connection with the

additions to tax for fraud. Respondent contends that The Five

made payments over a number of years to Kanter, Ballard, and/or

Lisle that were kickbacks or payoffs devised by Kanter, Ballard,

and/or Lisle. These various transactions or activities involving

The Five and the payments by them have been identified and

referred to by respondent as the “Prudential scheme”, the

“Travelers transaction”, and the “Kanter transaction”. For

instance, under the Prudential scheme, respondent contends that

Ballard and Lisle used their positions at Prudential to influence

and cause Prudential to award business to individual members of

The Five. In return for Ballard’s and Lisle’s services, each

member of The Five made payments to an entity or entities owned
 -67-

or controlled by Kanter. In turn, Kanter and/or entities under

Kanter's control transferred some or all of those payments to one

or more entities, and, through a succession of transfers, the

moneys ultimately filtered down to Ballard, Lisle, and Kanter,

either as corporate capital contributions or in the form of

loans, which were never repaid and later written off as

uncollectible. Respondent variously characterized the operation

as “schemes” by which payments by The Five went figuratively into

a “black box” from which there was a “drop down” to and through

various entities until the moneys reached Ballard, Lisle, and

Kanter. In actuality, respondent argues, the payments under the

Prudential scheme constituted kickback income to Kanter, Ballard,

and Lisle, which Kanter, Ballard, and Lisle fraudulently failed

to report on their respective income tax returns.

As the Court understands the case, respondent’s claim of

fraud is not based, per se, on the payments by The Five to Kanter

or any of the other entities to which such payments were

directed. The record is clear, and respondent does not challenge

the fact, that all payments made by The Five were reported as

income on the Federal income tax returns of the entities

receiving such payments. Respondent’s claim of fraud essentially

is based upon (1) the failure of Ballard, Lisle, and Kanter to

report, as income, amounts that were “dropped down” to them as

loans that were never repaid, and (2) as to Kanter, for moneys he
 -68-

personally earned that he directed be paid to IRA or other

entities he controlled and, as to which, Kanter failed to report

on his individual income tax returns.

Respondent maintains that the failure of Kanter, Ballard,

and Lisle to report the Prudential scheme, Travelers transaction,

and Kanter transaction income constituted fraud under section

6653(b), for 1978 through 1989. The entities that make up The

Five and a brief description of each follows:

(1) Hyatt Hotels Corp., a subsidiary of Hyatt Corp. (Hyatt).

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

Caribbean. As indicated previously, members of the Pritzker

family control the ownership of Hyatt. Kanter represented the

Pritzkers for years as their attorney. In 1979, IRA acquired KWJ

Corp., a corporation that had been receiving certain “commission”

payments from Hyatt on the management fees Hyatt earned in

operating the Hyatt Embarcadero Hotel at San Francisco,

California. The Hyatt Embarcadero Hotel had been developed and

was owned by a joint venture in which Prudential was a

participant. The commission payments, respondent contends,

constituted part of the kickback scheme.

(2) Bruce J. Frey, D.M. Interstate, the B.J.F. Development

Co. Partnership, and BJF, Inc. Bruce J. Frey was the principal

in each of these latter entities. Mr. Frey, through these

entities, managed apartments, office buildings, and commercial
 -69-

properties. He and these entities were also heavily involved in

a number of condominium conversion projects in various cities

around the country, in many of which Prudential held interests.

Mr. Frey and his related entities shared certain fees with Kanter

and his related entities, which respondent also contends

constituted part of the kickback scheme.

(3) William D. Schaffel. Mr. Schaffel was a mortgage broker

and real estate developer. Mr. Schaffel also assisted a New

Jersey general contracting company to obtain certain construction

contracts. From 1979 through 1986, he had extensive business

dealings on behalf of individuals he represented with Prudential

and Travelers. Mr. Schaffel shared with Kanter and his related

entities brokerage and development fees, which respondent claimed

was part of the kickback scheme.

(4) Property Management Systems, Inc. (PMS). The chairman

and chief executive officer of PMS was Kenneth Schnitzer. PMS

managed office buildings and other commercial real estate for

others pursuant to property management contracts. A relatively

small portion of its business included contract cleaning or

janitorial services on some Texas commercial properties it

managed. At one point, IRA acquired and owned a 47.5-percent

stock interest in PMS. Certain fees of PMS were also shared with
 -70-

Kanter and his related entities, which respondent claimed was

part of the kickback scheme.40

(5) Essex Hotel Management Co. (Essex Partnership). The

Essex Partnership had the following partners holding the

partnership interests indicated:

Percentage
Partner partnership interest

IRA 26.125
THC 21.375
Motor Hotel Management Co.(MHM) 47.500
John Connolly 5.000

John Eulich was the majority shareholder of Motor Hotel

Management Co. (MHM), a corporation, that was engaged in the

hotel management business. John Connolly’s hotel management

company managed two hotels that were owned by Prudential. The

partnership agreement for the Essex Partnership is dated January

l, 1982. One of the Essex Partnership’s purposes was to provide

consulting and liaison services to some of its partners in

connection with their management of certain hotels. A

substantial portion of the management fees earned by John

Connolly and MHM was paid to the Essex Partnership, which

respondent contends was a part of the kickback scheme.

40
There is no evidence that any PMS fees were shared with
Kanter and his related entities.
 -71-

B. Comments Regarding the Introductory Statement and Brief
Introduction of The Five

The first two paragraphs of the introductory statement in

the STJ report regarding The Five do not include findings of fact

but rather represent a statement of the Special Trial Judge’s

understanding of respondent’s theory of the cases. A review of

respondent’s posttrial briefs reveals that the Special Trial

Judge misunderstood and/or misstated respondent’s position.

As an initial matter, the STJ report stated that it was

respondent’s contention The Five made payments “In return for

Ballard’s and Lisle’s services”. This statement suggests that

respondent asserted The Five were aware Ballard and Lisle were

using their influence to steer business to them and The Five

intended to compensate Ballard and Lisle for their actions. To

the contrary, respondent’s theory regarding the manner in which

the kickback scheme was carried out is articulated in

respondent’s Opening Brief at 568-567, as follows:

Suppose A says to B, “If I introduce you to C, and you
do business with C’s company, then I want 50% of
whatever money you make on the deal.” If B did
business with C, and, in turn, paid A 50% of what he
made, that is not a kickback. A received a finder’s
fee. However, further suppose, A went to C and said,
“Whatever business you give to B, I will give you a
percentage of the money B gives to me.” In this
situation, B may not even know about the arrangement
between A and C. B may believe he is getting business
from C because he does good work. Nevertheless,
respondent maintains that when C gives business to B
with the understanding that he will eventually receive
money generated by that business from A, that is a
kickback.
 -72-

Thus, respondent argued in his posttrial briefs that Schaffel,

Frey, Schnitzer, and Eulich generally were unaware Ballard and

Lisle were using their influence at Prudential to steer business

opportunities to them, and they generally believed they were

compensating Kanter for his influence. As discussed in greater

detail, see infra pp. 229-235, in the light of respondent’s

theory the STJ report gave undue weight to testimony by The Five

that they did not participate in a kickback scheme.

The STJ report also incorrectly stated: “respondent’s claim

of fraud is not based, per se, on the payments by The Five to

Kanter or any of the other entities to which such payments were

directed.” Respondent clearly asserted in his opening brief that

Kanter’s, Ballard’s, and Lisle’s actions were fraudulent because

(1) they knew all the payments from The Five to IRA and THC

represented income that was taxable to each of them individually,

and (2) Kanter, Ballard, and Lisle intentionally used IRA and THC

to (a) shelter the payments from The Five from taxation, and (b)

to channel the payments to themselves disguised as capital

contributions, loans, and payments to family members.

Respondent’s Opening Brief at 556-557.

In addition, the statement in the STJ report limiting

respondent’s theory of fraud to the failure of Kanter, Ballard,

and Lisle to report as income amounts “dropped down” to them in

the form of loans is inaccurate and incomplete. In fact,
 -73-

respondent claimed that Carlco, TMT, and BWK were owned by Lisle,

Ballard, and Kanter, respectively, and, therefore, a much larger

portion of the payments from The Five, a total of some $6.7

million, was transferred to Kanter, Ballard, and Lisle through

so-called capital contributions to Carlco, TMT, and BWK. Id. at

459-473, 598-601. Though not to be ignored, the loans

represented relatively small amounts of the moneys that

respondent alleged were passed along from The Five, through

Kanter-related entities, to Kanter, Ballard, and Lisle.

III. Details Regarding The Five

A. Certain Payments Made by The Five (STJ report at 32-33)

Prior to and during the years at issue, Prudential was

perhaps the largest holder of commercial real estate in the

United States. By the late 1970s, it either held or was

responsible for managing an estimated $20 billion in commercial

real estate properties. In addition to its extensive commercial

real estate holdings in numerous cities throughout the United

States, since the 1960s, Prudential also was involved in

developing commercial real properties and in extending financing

to other real estate developers on various real estate projects

around the country.

As indicated previously, by the middle of 1982, Ballard and

Lisle each had left Prudential. After leaving Prudential, Lisle

obtained a similar position at Travelers. Respondent’s case for
 -74-

fraud is based upon payments made over several years from several

entities and/or individuals that have been collectively referred

to by respondent as The Five. The following narrative describes

The Five and the nature of their payments.

1. Hyatt Corp.’s Payment of a Share of Its Profits on the
Embarcadero Hotel’s Management Contract to KWJ Corp.
(STJ report at 33-37)

From 1968 through 1972, Ballard and J.D. Weaver (Weaver), an

executive with Tenneco Corp. (Tenneco) played instrumental roles

in their respective employers’ joint development of what would

become the Houston Hyatt Hotel. Weaver was president of

Tenneco’s real estate development subsidiary. Ballard, Transcr.

at 115. Ballard negotiated the Houston Hyatt Hotel’s management

contract with A.N. Pritzker of Hyatt Corp. A.N. Pritzker and his

sons had reputations as tough negotiators. Ballard, Transcr. at

125. Hyatt Corp. was awarded the management contract for the

Houston Hyatt Hotel no later than 1970. Ballard, Transcr. at

114-120, 126.41

Lisle also worked on the Houston Hyatt Hotel project for

Prudential. Friend, Transcr. at 767-768, 772-777. A.N. Pritzker

41
Hugo M. Friend, Jr. (Friend), a Hyatt Corp. vice
president, met Ballard and assisted Lisle and Tenneco
representatives in the selection of architects and contractors
for the Houston project during 1968 or 1969, a fact which
suggests that Hyatt Corp. was awarded the management contract for
the Houston Hyatt Hotel well before 1970. Friend, Transcr. at
750, 767-768, 773.
 -75-

first introduced Kanter to Lisle as one of Hyatt Corp.’s

representatives during the period 1968 to 1970 in connection with

the Houston Hyatt project. Exh. 2030, at 10-11. Beginning in

1970, Lisle oversaw the development and construction of the

Houston Hyatt Hotel as president of PIC Realty. Ballard,

Transcr. at 115, 119; Exh. 2030, at 2.

During the early 1970s, before the Houston Hyatt Hotel was

completed, Prudential was also participating in a joint venture

to develop and own the Embarcadero Hotel in San Francisco. Along

with Prudential, the other partners in the Embarcadero Hotel

project were David Rockefeller, Trammel Crow, and John Portman

(an architect). Ballard, Transcr. at 130; Friend, Transcr. at

759. As none of the joint venture participants possessed the

experience, knowledge, and skill needed to manage and operate the

hotel, they endeavored to have an experienced major hotel

management company operate the hotel under a long-term management

contract.

Lisle was supervising the Embarcadero Hotel’s development

for Prudential and was involved with Prudential and the other

joint venture participants in the selection of a management

company to manage the hotel. Del Webb, a well-known hotel

operator and owner of a large hotel management company, and
 -76-

Intercontinental Co., another large hotel management company,

were competing for the management contract.

A.N. Pritzker also was interested in having the Hyatt Corp.

manage the hotel because the Embarcadero Hotel then would become

the third or fourth Hyatt-operated hotel in the United States at

which major conventions could be held. As a result of Ballard’s

experience in negotiating the Houston Hyatt Hotel’s management

contract, Knab (Ballard and Lisle’s superior at Prudential)

directed Ballard to review and evaluate the terms of the proposed

management contracts to be considered for the Embarcadero Hotel.

Kanter addressed some tax issues on behalf of Hyatt Corp. with

regard to the Embarcadero Hotel. Kanter, Transcr. at 3669.

The Embarcadero Hotel was considered a spectacular property,

and both Del Webb and A.N. Pritzker wanted the management

contract for their respective companies. Ballard, Transcr. at

135-137, 142. Initially, Lisle was not interested in having

Hyatt Corp. manage the Embarcadero Hotel. Lisle opposed Hyatt

Corp.’s participation in the bidding on the Embarcadero Hotel

management contract because A.N. Pritzker had recently paid John

Portman to prepare a set of plans for another hotel in the Nob

Hill area of San Francisco. Ballard, Transcr. at 135-137.

However, Weaver, the Tenneco executive who had worked with

Ballard in developing the Houston Hyatt Hotel, eventually
 -77-

persuaded Lisle to allow Hyatt Corp. to be considered for the

Embarcadero Hotel's management contract.42 Weaver intervened

with Lisle on behalf of Hyatt Corp. because A.N. Pritzker

promised Weaver a 10-percent share of the “retained profits”

Hyatt Corp. might earn managing the Embarcadero Hotel if Weaver

could persuade Lisle to allow Hyatt Corp. to bid on the contract.

Ballard, Transcr. at 127, 135-137;43 Exh. 362.

42
Tenneco Corp., Weaver’s employer, apparently did not
have any equity or other interest in the Embarcadero Hotel
project. The record does not fully disclose the circumstances
that caused and led Mr. Weaver to persuade Lisle to allow Hyatt
Corp. to compete for the Embarcadero Hotel’s management contract,
nor does the record disclose what specific past dealings Mr.
Weaver may have had with Lisle. While both Lisle and A.N.
Pritzker died before the trial of the instant cases, Mr. Weaver’s
testimony was not offered by the parties. As Lisle had
previously worked in Prudential’s Houston regional office, Lisle,
in all likelihood, had already been acquainted with Mr. Weaver,
as Mr. Weaver had been employed in Tenneco’s real estate
operations for some time and, beginning in about 1968, had worked
with Ballard in putting together the development project for the
Houston Hyatt Hotel. (Emphasis added.)

The first clause emphasized above is incorrect. The
circumstances that led Weaver to influence Lisle to allow Hyatt
Corp. to bid on the Embarcadero Hotel management contract are set
forth in additional findings of fact in the text that follows.

The second clause emphasized above is notable. Ballard
denied ever meeting Weaver. Ballard, Transcr. at 247. Ballard’s
testimony on this point was not credible.
43
Ballard testified: “Mr. Weaver was bugging Mr. Lisle to
let Pritzker bid on the hotel.” Ballard, Transcr. at 127.
 -78-

Ballard recognized that Lisle alone held the power to bar

Hyatt Corp. from bidding on the Embarcadero Hotel management

contract, and there is no suggestion the other partners in the

Embarcadero Hotel project had any direct input regarding the

bidding process. Ballard, Transcr. at 130, 135-137.

Subsequently, Ballard, Lisle, other Prudential employees,

and representatives of the other joint venture participants met

with Del Webb and A.N. Pritzker to obtain their respective bids

on the Embarcadero Hotel’s management contract. The third

bidder, Intercontinental Co., unexpectedly did not attend the bid

meeting. Ballard, Transcr. at 136, 269. Ballard considered it

unusual for Del Webb to attend such a meeting in person, as

opposed to sending a representative. Ballard, Transcr. at 138.

During the meeting, Mr. Webb refused to submit a bid on

behalf of his hotel management company, as Mr. Webb claimed that

it was his understanding that Mr. Webb’s company was to receive

the management contract. Although Lisle and other

representatives of the joint venture participants then asked Mr.

Webb how he believed this was so, Mr. Webb refused to elaborate.

A.N. Pritzker offered to have Hyatt Corp. enter into a management

contract for the Embarcadero Hotel substantially similar to the

Houston Hyatt Hotel’s management contract. As Hyatt Corp.

submitted the only bid, A.N. Pritzker’s proposal was accepted,
 -79-

and a management contract for the Embarcadero Hotel along those

lines was ultimately entered into by Hyatt Corp., Prudential, and

the other joint venture participants. Hyatt Corp. was awarded

the Embarcadero Hotel management contract without any competing

bid. Ballard, Transcr. at 136.

KWJ Corp. was an S corporation solely owned by Weaver. In

early 1971, shortly after winning the Embarcadero Hotel

management contract, Hyatt Corp. entered into a “Memorandum Of

Agreement” with KWJ Corp. (the Hyatt/KWJ agreement), whereby

Hyatt Corp. agreed to pay KWJ Corp. an annual commission

generally equal to 10 percent of Hyatt Corp.’s “net cash profits”

from the Embarcadero Hotel management contract. The Hyatt/KWJ

agreement stated: “KWJ has been the principal factor in bringing

the parties together and aiding in the negotiations” with regard

to the Embarcadero Hotel management contract. Exh. 362, at 2.

The Hyatt/KWJ agreement purportedly was authorized by Hyatt

Corp.’s executive officers under a document entitled “Certificate

of Secretary”, which bore the signature of Hugo M. Friend, Jr.

(Friend), an executive vice president, secretary, and director at

Hyatt Corp. during the period in question. Exh. 362; Friend,

Transcr. at 748-749, 753. Friend’s sister was married to Jay

Pritzker, one of A.N. Pritzker’s sons. Friend, Transcr. at 750.
 -80-

The Certificate of Secretary stated that a special meeting

of Hyatt Corp.’s executive committee of the board of directors

had been held, and a resolution was adopted authorizing Hyatt

Corp. to enter into an agreement with KWJ Corp. “for KWJ’s

services rendered in connection with * * * [Hyatt Corp.’s]

entering into a lease” with regard to the Embarcadero Hotel.

Exh. 362. Friend first learned of the Hyatt/KWJ agreement well

over a year later, in June 1972, and he was surprised to see that

his name had been signed on the document. Friend, Transcr. at

752-755. Friend investigated further and learned that Donald

Pritzker, another of A.N. Pritzker’s sons and president of Hyatt

Corp. at the time, had his secretary, Joanne Brown, sign Friend’s

name on the document. Friend, Transcr. at 754. Friend also

learned the agreement was entered into because of Weaver’s

substantial influence in obtaining the Embarcadero Hotel

management contract for Hyatt Corp. Friend, Transcr. at 764.

Another Hyatt Corp. document, a “Memorandum To The Files”,

prepared by Leonard W. Stoga, Hyatt Corp.’s chief financial

officer, dated February 27, 1982, stated that Weaver earned the

fee “as a result of arranging the management agreement between

Hyatt * * * and Prudential.” Exh. 464; Stoga, Transcr. at 804-

807.
 -81-

Following the Embarcadero Hotel deal, Hyatt Corp. abandoned

the Nob Hill hotel project. Ballard, Transcr. at 135-137.

Prudential later built 8 to 10 Hyatt hotels in cities including

New Orleans, Cambridge (Massachusetts), Indianapolis, Nashville,

Chicago, and Oahu, Hawaii. Ballard, Transcr. at 135; Friend,

Transcr. at 770-771. Friend often conferred with Ballard and/or

Lisle when Hyatt Corp. contemplated replacing a hotel manager at

a Prudential-financed hotel. Id.

Kanter purportedly met Ballard and Weaver for the first time

in the fall of 1972 at the opening of the Houston Hyatt Hotel.

Kanter, Transcr. at 3602-3603, 3652; Friend, Transcr. at 759.44

Kanter testified he first learned of Hyatt Corp.’s agreement

to share its fees on the Embarcadero Hotel’s management contract

with KWJ Corp. in about 1973, when A.N. Pritzker asked Kanter to

review the agreement.

Ballard testified he learned of the Hyatt/KWJ agreement from

A.N. Pritzker, after the fact and in connection with discussions

regarding the other Prudential-financed hotels mentioned above.

Ballard, Transcr. at 134-135. Ballard testified that A.N.

Pritzker volunteered that Hyatt Corp. paid a finder’s fee to

44
The record strongly suggests Kanter met Ballard and
Weaver during the period 1968 to 1970--the same time A.N.
Pritzker introduced Kanter to Lisle in connection with the
Houston Hyatt Hotel project. Exh. 2030, at 10-11.
 -82-

Weaver on the Embarcadero Hotel, but A.N. Pritzker sought to

assure Ballard that Hyatt Corp. did not pay finder’s fees on its

management contracts. Id.

In early 1975, a dispute arose between Weaver and Hyatt

Corp. with regard to the commission due to KWJ Corp. for 1974.

Friend informed Weaver that the Embarcadero Hotel did not

generate a net profit for 1974. Exh. 9101. Weaver wrote to

Friend and claimed that Hyatt Corp.’s revenue from the

Embarcadero Hotel for 1974 under its management contract with

Prudential was $612,201 and that KWJ Corp. was entitled to 10

percent of that amount. Id. A.N. Pritzker responded to Weaver

by letter and asserted that KWJ Corp.’s share of the fees would

have to be reduced by a share of Hyatt Corp.’s home office

expenses. Exh. 9102. Weaver wrote back to A.N. Pritzker

disagreeing with this approach. Exh. 9103.

During 1975, A.N. Pritzker brought the Hyatt/Weaver dispute

to Kanter’s attention and requested his advice. Kanter, Transcr.

at 3646-3650. During this period, Kanter and Weaver discussed

and negotiated Mr. Weaver’s sale of KWJ Corp. to Kanter’s

“client”, IRA. Following these negotiations, in his letter to

Kanter dated March 10, 1976, Mr. Weaver confirmed “our

understanding regarding my granting to your client a right

[option] to purchase all of the outstanding shares of stock of
 -83-

KWJ Corp.” for $150,000 and Mr. Weaver’s continuing right to

receive an amount equal to 30 percent of the payments KWJ Corp.

received from Hyatt Corp. on the Embarcadero Hotel’s management

contract.45

Kanter testified that Weaver agreed in the mid-1970s to sell

KWJ Corp. to IRA for $150,000 because he needed the money.

Kanter, Transcr. at 3652-3653. There is no indication in the

record that the option Weaver granted to Kanter had any

independent value--Weaver simply granted IRA an open-ended option

to purchase KWJ Corp. for $150,000. Exh. 9103. As discussed

below, IRA’s purchase of KWJ Corp. was delayed until 1979 after

Hyatt Corp. had become a privately held corporation.46

45
Hyatt Corp.’s fees under the Embarcadero Hotel’s
management contract were based, in substantial part, on the
hotel’s operational profits. The Embarcadero Hotel opened for
business in 1973. During the first few years of the hotel’s
operation, the “commissions” KWJ Corp. received from Hyatt Corp.
were less than Mr. Weaver had expected. According to Kanter, at
the time he and Mr. Weaver negotiated KWJ Corp.’s sale to IRA,
Mr. Weaver needed money. Beginning in about the late 1970s the
Embarcadero Hotel’s profits increased significantly. Part of
this increased profitability was attributable to improvements
that Hyatt Corp. helped to finance by lending about $1 million to
the Embarcadero Hotel’s owners for certain improvements to the
hotel.
46
Although Hyatt Corp. often did pay finder’s fees or
commissions to individuals helping it to obtain valuable business
contracts, Hyatt Corp. also did not want to publicize the
specific payment amounts. It believed that such public
disclosure would cause other individuals to demand similar
compensation for future business opportunities to Hyatt Corp.
 -84-

In the meantime, correspondence from Hyatt Corp. to Weaver

shows that (1) Hyatt Corp. revised its Embarcadero Hotel

management contract with Prudential sometime in late 1975, (2) a

question arose whether KWJ Corp.’s commission would be computed

under the old Embarcadero Hotel management contract or the new

Embarcadero Hotel management contract, (3) Hyatt Corp. paid KWJ

Corp. $54,848 for 1976 and $60,739 for 1977,47 and (4) Weaver was

informed in 1978 that the Embarcadero Hotel’s performance was

improving and commission payments to KWJ Corp. would be

increasing. Exh. 364; Exh. 9103, at 12; Exh. 4003.

By letter dated September 27, 1979, Kanter informed Weaver

that IRA wanted to proceed with the purchase of KWJ Corp.,

effective retroactively to November 1, 1978. Exh. 365. In 1979,

IRA purchased 100 percent of KWJ Corp.’s outstanding shares of

stock from Mr. Weaver. Specifically, IRA issued to Weaver a

$150,000 promissory note which provided that Weaver was to be

paid $10,000 on or before November 30, 1979, and $140,000 (with

interest at 12 percent) on or before July 31, 1980. Exh. 9103,

at 29. On November 26, 1979, 4 days before IRA was obliged to

pay Weaver $10,000 in cash on the note, Grogan, on behalf of IRA,

47
Hyatt Corp.’s payments to KWJ Corp. normally were
remitted in the spring of the year immediately following the
contract year. Exh. 4003.
 -85-

sent Weaver a letter requesting that Weaver accept “a note of a

third party, International Films, Inc.” (IFI), one of IRA’s

subsidiaries, reflecting an obligation due from IFI to IRA in

full payment of the $10,000 amount due. Exh. 9103, at 30.

Weaver agreed to this proposal. On November 30, 1979, Grogan, on

behalf of IRA, sent Weaver a document purporting to be an IFI

note payable to IRA for $10,000 which was assigned to Weaver.

Exh. 9103, at 31-32. On March 12, 1980, Meyers, on behalf of

IFI, sent a letter to Weaver requesting that he agree to extend

to July 1, 1980, the time in which IFI had to pay him $10,000.

Exh. 9103, at 36. On July 2, 1980, IFI purportedly paid Weaver

$10,907.37 by check signed by Grogan. Exh. 9103, at 37. (The

record does not reflect whether this check was negotiated.) On

August 1, 1980, Kanter sent Weaver a letter purportedly

forwarding a check in the amount of $154,176.44 for the stock of

KWJ Corp. Exhs. 9103, 38. (The record does not reflect whether

this check was negotiated.)

The fact that Weaver did not receive payment on his sale of

KWJ Corp. to IRA until August 1980 casts serious doubt on

Kanter’s testimony that Weaver agreed to sell KWJ Corp. for

$150,000 in 1976 because he needed the money. Kanter, Transcr.

at 3652-3653.
 -86-

As a result of IRA’s purchase, KWJ Corp. was included as a

subsidiary on IRA’s 1979 consolidated tax return. Exh. 10, at

7, 19. IRA’s 1979 consolidated return reflected KWJ Corp.’s

assets, liabilities, and net worth as of January 1, 1979, as

follows:

Assets Amount

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

Exh. 10.

KWJ Corp.’s accrued income of $108,521 as of January 1,

1979, nearly equaled the sum of the $54,848 and $60,739

($115,587) payments that KWJ Corp. received from Hyatt Corp. in

1976 and 1977, respectively. Exh. 9103, at 12; Exh. 4003. IRA’s

1979 consolidated return reported that KWJ Corp. had gross

receipts of $171,027 for 1979, and $51,308 of that amount (the 30

percent paid to Weaver) was deducted as a commission expense.
 -87-

Exhs. 10, 4003. IRA’s share of the 1979 Hyatt Corp. payment

alone provided IRA with nearly the full $150,000 purchase price

for KWJ Corp. KWJ Corp.’s contract with Hyatt Corp. was worth

millions of dollars. Exh. 4003. By selling KWJ Corp. to IRA,

Weaver gave up 70 percent of his contract rights under the

Hyatt/KWJ agreement.

Neither Weaver nor Kanter immediately informed Hyatt Corp.

that IRA had purchased KWJ Corp. Handelsman, Transcr. at 1136-

1137. Consequently, Hyatt Corp. continued to send to Weaver

checks made payable to KWJ Corp. Handelsman, Transcr. at 1136-

1137; Stoga, Transcr. at 813. From 1977 through 1994, Hyatt

Corp. paid KWJ Corp. approximately $2.5 million pursuant to the

Hyatt/KWJ agreement. Exhs. 4003, 465, 466, 467, 378, 380, 381;

Stoga, Transcr. at 808-811; Handelsman, Transcr. at 1141, 1143-

1144. Weaver forwarded each of the Hyatt Corp. payments to

Kanter. Exhs. 4003, 373, 9103 (e.g., Weaver letters to Kanter

dated March 29, 1983, and March 12, 1984). Kanter then returned

30 percent of the Hyatt Corp. fees to Weaver, and IRA deducted

those payments as a commission expense. Exh. 10, at 16; Exh. 14,

at 7; Exh. 17, at 15-16; Exh. 18, at 20; Ex. 9103 (e.g., TACI

check to Weaver dated March 27, 1984).
 -88-

By letter dated March 29, 1983, Weaver forwarded to Kanter

the most recent payment from Hyatt Corp. Weaver’s letter stated

in pertinent part:

Dear Burt:

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. [Exh. 373].

In December 1983, IRA liquidated KWJ Corp., and IRA’s

subsidiaries, BWK, Carlco, and TMT received its assets. BWK,

Carlco, and TMT then formed a partnership called KWJ Co. (KWJ

Partnership), to which they contributed all of the assets they

received from KWJ Corp.’s liquidation. Carlco and TMT each had a

45-percent interest in KWJ Partnership; BWK had a 10-percent

interest in the partnership. On January 10, 1984, Carlco, TMT,

and BWK made capital contributions to KWJ Partnership in the

respective amounts of $2,745, $2,745, and $610. Exh. 69, at 8;

Exh. 93, at 9; Exh. 114, at 6; also Exh. 9104, at 10.

Neither Weaver nor Kanter immediately informed Hyatt Corp.

that KWJ Corp. had been liquidated. Exh. 9104; Handelsman,

Transcr. at 1136-1137. Consequently, Hyatt Corp. continued to

send to Weaver checks made payable to KWJ Corp. Id.
 -89-

Beginning in 1984, the Hyatt Corp. payments that Weaver

continued to forward to Kanter were no longer reported on IRA’s

consolidated returns. Rather, Carlco, TMT, and BWK reported

their distributive shares of this money passed through to them

from KWJ Partnership. Exhs. 69-74 (Carlco general ledgers);

Exhs. 93-98 (TMT general ledgers); Exhs. 114-119 (BWK general

ledgers).

In August 1992, after the IRS began its examination in these

cases, Kanter informed Hyatt Corp. that IRA had purchased and

later liquidated KWJ Corp., and that KWJ Corp.’s assets were

transferred to Carlco, TMT, and BWK and then contributed to KWJ

Partnership. Exh. 9104. As of the time of trial, Hyatt Corp.

continued to send its payments to Weaver in the form of checks

made payable to KWJ Corp. Handelsman, Transcr. at 1137.

During the period 1977 to 1994, Hyatt paid to KWJ Corp. the

amounts set forth in the following table.48

48
Hyatt Corp.’s records are inconsistent with IRA’s
records with regard to the years in which the payments listed
above were paid. We rely on Hyatt Corp.’s records regarding the
timing of the payments for purposes of these cases.
 -90-

Table 2

Year Amount

1977 $54,848
1978 60,739
1979 --
1980 171,027
1981 128,671
1982 246,717
1983 245,843
1984 265,846
1985 295,415
1986 330,376
1987 327,784
1988 281,926
1989 75,396
1990 24,340
1991 23,288
1992 21,332
1993 21,251
1994 14,911
Total 2,589,710

Exh. 4003. Although Hyatt Corp. was unable to find a record of

any payment to KWJ Corp. for the 1978 contract year, Harold S.

Handelsman, Hyatt Corp.’s general counsel, believed that a

payment was made to KWJ Corp. for 1978. Handelsman, Transcr. at

1142.

As discussed in detail in additional findings of fact, infra

pp. 192-194, KWJ Corp., and later KWJ Partnership, paid

substantial amounts to Ballard’s and Lisle’s adult children

during the period 1982 to 1989, and those amounts were deducted

as consulting fees.
 -91-

2. Bruce Frey’s Payments to IRA From 1980 Through 1985 and
to THC in 1981, 1983, 1984, and 1987 (STJ report at 37-
42)

Bruce Frey was a certified property manager, real estate

broker, and the principal in D.M. Interstate Management, Inc.

(D.M. Interstate), a real estate property management company that

was an S corporation.49 By January 1980, Frey organized a

corporation, BJF Development, Inc. (BJF, Inc.), to engage in the

business of condominium conversions. Exh. 5800; Frey, Transcr.

at 653-654. As discussed in detail below, Frey, his business

associate, James Wold (Wold), and BJF, Inc. (as general

partners), organized a number of limited partnerships for the

purpose of carrying out condominium conversion projects, selling

the condominium units, and providing ongoing management services

for the condominium association. Exh. 5800; Frey, Transcr. at

659-660, 663.

On June 15, 1984, Frey, Wold, and BJF, Inc., as general

partners, and TSG Holdings, Inc., FWID, Ltd., and THC formed a

limited partnership known as BJF Development, Ltd. (BJF

Partnership), to engage in condominium conversion projects and

49
The second, third, and fourth sentences in the opening
paragraph of the STJ report describing business entities operated
by Bruce Frey (Frey) are incorrect. A correct statement of those
facts is set forth in additional findings of fact in the text
that follows.
 -92-

related business. Exh. 223. BJF Partnership is discussed in

greater detail below.

In many instances, Frey’s limited partnerships acquired an

apartment complex, renovated and converted it into condominium

units, and sold the condominium units to individual purchasers.

Frey explained that he purchased apartment buildings at their

rental value and, after refurbishing and converting the

apartments to condominium units, he was able to turn a profit by

selling the units to individual owners. Frey, Transcr. at 659.

Frey and/or another entity owned by him also typically earned

certain development and management fees on condominium

conversions. The development fees were for Frey’s and/or his

entity’s services in managing and supervising the renovation and

conversion work on the property, and the management fees were

paid for their services in assisting the property’s condominium

association manage the property following the property’s

conversion.

After successfully engaging in his first condominium

conversion project in Illinois in 1978 known as Moon Lake

Village, Frey consulted with Kanter to obtain tax advice in

connection with that project. Kanter was not involved as an

investor or partner in the Moon Lake Village project. Frey,

Transcr. at 662-663. During their meeting or shortly thereafter,
 -93-

Frey and Kanter discussed Frey’s pressing need to raise capital

for future condominium conversion projects. At that time, a

condominium conversion craze was occurring in a number of major

metropolitan areas throughout the country, and Frey was faced

with having to raise large amounts of capital to acquire and

convert apartment building properties in which he and other

competing condominium converters were interested. Although Frey

generally could obtain financing from a bank for most of a

condominium conversion project’s cost, the bank typically would

require Frey and other investors to have a substantial investment

in the project. Kanter indicated that he could help raise large

portions of the capital that Frey needed for such condominium

conversion projects.50 However, Kanter stated, in return for

such assistance, he would have to receive a share of any

development and management fees that Frey earned from such

projects.

Kanter made it clear to Frey that he would bring additional

investors and capital to Frey’s projects only if Frey agreed to

50
The STJ report included statements in this sentence and
the next that “Kanter and/or entities associated with him” could
provide assistance to Frey in raising capital. As discussed in
the text that follows, Frey was relying solely on Kanter to raise
capital for his condominium conversion projects. Frey, Transcr.
at 666-674. Aside from limited partner investments discussed
below, there is no evidence that anyone acting on behalf of a
Kanter-related entity, such as IRA or THC, provided any
assistance or services to Frey.
 -94-

pay Kanter a share of the fees that Frey earned for a given

project. Kanter told Frey: “I want to be on the same basis as

you. Whatever fees you participate in, I don't want you to have

an edge; if I am going to bring capital in and add value to these

partnerships, I don't want anyone to have an edge and I want to

participate in those fees.” Frey, Transcr. at 671. Frey

acknowledged that Kanter “had a role of more than just a passive

investor. His role was bringing in capital into the venture.”

Frey, Transcr. at 668.

Beginning in 1979-80 with Frey’s second and third

condominium conversion projects known as Lakewood and 535 North

Michigan Ave., respectively, entities associated with Kanter

invested, as limited partners, in a number of Frey’s condominium

conversion projects. The entities associated with Kanter that

invested in these condominium projects included Zeus Ventures,

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

a subsidiary of THC. Following through on his oral agreement

with Frey, Kanter also brought other investors and capital to the

Lakewood and 535 North Michigan Ave. projects.51 Frey, Transcr.

at 663-674; Wold, Transcr. at 2880. Kanter brought in the Marmon

51
In November 1979, D.M. Interstate Management, Inc.,
entered into an agreement to manage the Lakewood condominium
property. Exh. 223, app. A, pt. II, item 11.
 -95-

Trust as a major investor in the 535 North Michigan Ave. project.

Frey, Transcr. at 666, 673.

In return for Kanter’s bringing investors and capital to the

Lakewood and 535 North Michigan Ave. projects, Frey paid Kanter

10 to 20 percent of the development and management fees Frey

earned on those projects. Frey, Transcr. at 665-668; Wold,

Transcr. at 2865. Frey remitted these payments to Kanter-related

entities as directed by Kanter. Frey, Transcr. at 674; Wold,

Transcr. at 2861. At the same time, Zeus and Zion received

normal profits interests as limited partner investors in these

projects. Frey, Transcr. at 666.

Prudential was not involved in either the Lakewood or the

535 North Michigan Avenue conversion projects. Frey, Transcr. at

663-677.

The first condominium conversion project that Frey undertook

involving Prudential was in connection with a 1,000 unit

townhouse apartment complex called Village of Kings Creek at

Miami, Florida. In late 1979 or early 1980, Frey approached a

Prudential real estate department executive working in

Prudential’s Miami, Florida, regional office about purchasing the

Village of Kings Creek apartment complex. The apartment complex

was owned by a pension fund managed by Prudential. Frey offered

to purchase the apartment complex for a cash price of about $20
 -96-

million. He also advised the Prudential executive that another

insurance company, Connecticut Mutual Life Insurance Co., would

be joining Frey in purchasing the property. Prudential had

already considered selling the apartment complex, and Frey’s $20

million offer for the property significantly exceeded the

property’s appraised market value.

The Prudential executive consulted with Ballard about Frey’s

offer. Ballard advised the executive that Prudential, acting on

the pension fund's behalf, should accept the offer, as Ballard

felt that Prudential’s refusal of such an offer might constitute

a breach of fiduciary duty as investment manager of the pension

fund.

In 1980, Prudential sold the Village of Kings Creek

apartment complex to a limited partnership Frey organized to

undertake conversion of the property to condominiums. Zeus and

Zion participated as limited partners in this partnership,

contributing $100,000 and $108,014, respectively, to the Village

of Kings Creek partnership. Exh. 5800. Kanter also brought in

another investor, First Illinois Enterprises, that made a

substantial investment in the project. Wold, Transcr. at 2854.

During the Village of Kings Creek conversion process,

Ballard visited the property “to see what was going on down

there”, and he met Wold. Ballard, Transcr. at 178. During this
 -97-

same period, Kanter introduced Frey to Ballard at Prudential’s

headquarters in Newark. Ballard, Transcr. at 173-175.

The Village of Kings Creek condominium conversion project

was successful. The Village of Kings Creek partnership made a

distribution to its partners to cover the partners’ share of tax

liabilities. Wold, Transcr. at 2854-2855. In addition, Kanter

received a share of development fees earned on the project by way

of checks made payable to THC. Exh. 457; Wold, Transcr. at 2855,

2860-2861. Wold believed Kanter directed that the checks should

be written to THC. Wold, Transcr. at 2861.

Following Frey’s success with the Village of Kings Creek

project, the Miami regional office Prudential executive who Frey

had dealt with in purchasing that property approached Frey about

acquiring another Prudential apartment property in Florida.

Beginning with this property, Prudential ultimately participated

in a number of successful condominium conversion projects with

Frey. However, many, if not almost all, of these projects that

Frey and Prudential undertook were joint ventures. Entities

associated with Kanter, including Zeus and Zion, also were

investors in a number of these joint venture condominium

conversion projects of Frey and Prudential.

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

these joint venture projects with Prudential, as Prudential
 -98-

already owned the apartment property to be converted and sold to

individual condominium unit owners. Rather than Prudential’s

selling an apartment property to Frey and other investors,

Prudential elected to participate as co-owner in a joint venture

to convert and sell the property as condominium units.

Prudential would contribute the property and receive (1) all

initial condominium unit sale proceeds up to a specified amount

based, in large part, on the property's appraised fair market

value as a rental property, and (2) 50 percent of all other unit

sale proceeds above the initial specified amount. Frey and other

investors would usually form a limited partnership and were

responsible for renovating and converting the property and

selling the condominium units. The limited partnership that

included Frey and other investors received the other 50-percent

share of all unit sales proceeds above initial specified amount

of the sales proceeds. Frey and/or an entity owned by him also

earned development and management fees from the project.

Frey/Prudential joint venture projects included condominium

conversions known as The Greens, Chatham, Calais, Valleybrook,

and Old Forge. Frey, Transcr. at 677; Wold, Transcr. at 2868.

Prudential and BJF, Inc., entered into a series of consulting

agreements with regard to these projects between August 1, 1981,

and December 1981. Exh. 223, app. A, pt. II, items 13, 16, 19;
 -99-

Exhs. 221, 5814. Kanter received a share of development fees in

connection with each of the Prudential joint venture condominium

conversion projects listed above through checks made payable to

Zeus. Exh. 457; Wold, Transcr. at 2868-2870.

Kanter (through payments to Zeus) also received a share of

the fees Frey earned with respect to a Prudential condominium

project known as Galaxy Towers, a building that Lisle’s PIC

Realty had constructed. Exh. 457, at 2, 4, 8; Exh. 2030, at 25.

Although Prudential converted the Galaxy Towers to condominiums

on its own, Prudential hired Frey to serve as a consultant for

the conversion and to begin a marketing plan to sell the

condominiums. Frey, Transcr. at 684-685. In exchange for these

services, Frey’s company received consulting fees. Id. In

January 1982, Prudential and BJF, Inc., executed a consulting

agreement regarding the Galaxy Towers. Exh. 223, app. A, pt. II,

at 8, No. 22.

In the interim, on October 12, 1981, the existing agreement

that Frey had to share development and management fees with

Kanter was formalized in two separate written agreements.52 One

52
The statement in the STJ report that Frey agreed to
share his fees with “Kanter and/or entities associated with
Kanter” is manifestly unreasonable. Frey agreed to share fees
with Kanter, and Frey entered into the participation agreements
and remitted payments to Kanter-related entities only because
Kanter directed him to do so. Frey, Transcr. at 671-674.
 -100-

agreement was between BJF, Inc., and IRA’s subsidiary, Zeus, and

the other agreement was between BJF, Inc., and THC. These

written agreements covered projects in which Prudential apartment

properties were being converted, as well as other projects not

involving Prudential’s apartment properties.

a. The Frey/THC Agreement

On October 12, 1981, Frey sent a participation agreement to

Kanter, as president of THC, regarding THC’s “Participation in

Condominium Conversions” which provided, in part:

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 properties [sic] 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:

The Holding Company, a Delaware corporation,
its nominees and/or affiliates--(“THC”) 33%
 -101-

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:

THC 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. [Exh. 222.]

In sum, the Frey/THC agreement provided that, as to condominium

conversion projects involving Prudential properties, and any

future condominium conversion projects not involving Prudential,

properties, THC and Frey would participate in capital

contributions and profits and losses as 33-percent and 67-percent

partners, respectively. In addition, after October 1, 1981, THC

would receive 5 percent of any development fees derived from any

condominium conversion projects not involving Prudential properties.
 -102-

b. The Frey/Zeus Agreement

On October 12, 1981, Frey sent a participation agreement to

Meyers (as president of Zeus, IRA’s subsidiary) regarding

“Participation in Proceeds on Prudential Conversions” which

provided, in part:

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
 -103-

Prudential of the Developers’ Fees and assigned profits (as
the case may be). [Exh. 221.]

In sum, the Frey/Zeus agreement provided that Frey would pay to

Zeus (1) the equivalent of 5 percent (20% x 25%) of development

fees earned on Prudential condominium conversion projects, and

(2) 20 percent of “assigned profits” on Prudential condominium

conversion projects excluding any management fees. The Frey/Zeus

agreement stated that the term “assigned profits” was intended to

cover all compensation paid to BJF, Inc., by Prudential under

certain condominium conversion consulting agreements (citing as

an example a BJF/Prudential consulting agreement on a project

known as Old Forge). Id.

The Frey/Zeus participation agreement formalized Frey’s and

Kanter’s prior oral agreement to share development fees and

extended that agreement to cover assigned profits on Prudential

projects.

Consistent with Frey’s oral agreement with Kanter, as

subsequently formalized in the Frey/THC agreement and the

Frey/Zeus agreement, BJF, Inc., remitted monthly, and later

quarterly, payments to Kanter during the period December 1981 to

late 1984, representing THC’s and Zeus’s shares of development

fees and assigned profits arising from condominium conversion

projects at Village of Kings Creek, Calais, Chatham, and
 -104-

Valleybrook. Exhs. 224, 225, 228 (checks written against a D.M.

Interstate Management, Inc. account).

A letter to Kanter from BJF, Inc., dated October 31, 1983,

stated in pertinent part:

Dear Mr. Kanter:

Please find enclosed our check #8135 for $15,000.00.
This represents your 5% participation of our
$300,000.00 incentive fees received from Prudential for
50% of units closed at Calais, Chatham and Valleybrook.
[Exh. 225.]

The accompanying check, made payable to Kanter, was later voided

and a replacement check was issued to Zeus. Exh. 229; Exh. 456

at 16; Busse, Transcr. at 735-736.

c. BJF Partnership

As previously mentioned, in June 1984, BJF Partnership was

formed. Exh. 223. The partnership agreement provided that THC

was entitled to 13.125 percent of the partnership’s cash

distributions, but THC was obliged to remit 17.5 percent of the

partnership’s capital contributions. Id. at 12; Exh. 5802.

Article II of the partnership agreement recited that the partners

assigned or transferred to the partnership the items specified in

part II of appendix A. Exh. 223, at 8. Part II of appendix A of

the partnership agreement listed 24 items transferred to the

partnership including (1) various management and consulting

agreements between BJF, Inc., and Prudential related to
 -105-

condominium conversion projects at Calais, Chatham, Valleybrook,

and Galaxy Towers, and (2) “Two Participation Agreements with

Burton J. Kanter regarding certain condominium conversions.

These agreements have been terminated with respect to new

conversions.” Exh. 223, app. A., pt. II, at 5-8. The BJF

Partnership agreement included representation and warranty

clauses under which Kanter stated that (1) he did not need any

consent, authorization, or approval to contribute the

participation agreements to the partnership, (2) the terminations

of the participation agreements were valid, binding, and

effective, and (3) THC is a corporation owned by a trust all the

beneficiaries of which are Kanter family members. Id. at 65, 70,

par. 8.4(c).

THC did not make any direct cash contributions to BJF

Partnership when it acquired its limited partnership interest. A

June 20, 1984, letter to Kanter from a law firm involved in the

matter indicated (1) THC was obliged to make a $29,913 cash

contribution to the partnership, (2) THC owed $86,789 to FWID for

making cash equivalent contributions on THC’s behalf, and (3) THC

should issue a secured note to FWID in the amount of $88,387 for

contributing other assets to the partnership’s capital on THC’s

behalf. Exh. 5802. On December 31, 1984, however, TSG Holdings

purchased additional interests in BJF Partnership from THC and
 -106-

the other partners. Exhs. 5804, 5806, 5808. THC’s share of the

payments made by TSG Holdings totaled $241,951, and THC actually

received $197,757 of that amount (with $44,194 having been

remitted to Frey in repayment of a portion of the amount that

Frey had contributed to the partnership on THC’s behalf.) Exhs.

5809, 5811.

During the period October 1984 to July 1987, BJF

Partnership issued separate checks to THC representing (1) shares

of development fees for Village of Kings Creek, and (2)

partnership distributions attributable to its limited partnership

interests. Exhs. 226, 457. During the same period, BJF

Partnership issued checks to Zeus representing (1) shares of

development fees and incentive payments attributable to

Prudential condominium conversion projects at Galaxy Towers,

Calais, Chatham, and Valleybrook. Exhs. 227, 457.

d. Summary of Frey Payments to Zeus

During 1980 through 1985, Frey (through BJF, Inc., and BJF

Partnership) paid to IRA’s subsidiary, Zeus, the amounts set

forth in the following table.53

53
For a more detailed breakdown of the payments from Frey
to Zeus, see app. 1 to this report.
 -107-

Table 3

Year Amount Exhibits

1980 $127,372 Exh. 12, stmts. 7 and 25, at 7,
Kuck, Transcr. at 3371-3373
1981 105,764 Exh. 14, at 7, ll. 2, 6, 7;
Exhs. 5814, 5817;
Kuck, Transcr. at 3378-3384
1982 538,781 Exh. 17, at 16, l. 4; Kuck,
Transcr. at 3409
1983 110,125 Exhs. 18, 224, 456, 5815, 5818
1984 103,500 Exhs. 19, 225, 456, 457, 5819
1985 128,763 Exhs. 20, 457
Total 1,114,305

e. Summary of Frey Payments to THC

During 1981 to 1987, Frey (through BJF, Inc., and BJF

Partnership) paid to THC the amounts set forth in the following

table.

Table 4

Year Amount Exhibits

1981 $80,616 5814, 5817
1982 -- -–
1983 16,200 14, 224, 5815
1984 113,827 224-226
1985 256,557 226, 5810, 5811
1986 -- -–
1987 33,570 226
Total 500,770

3. Payments From William Schaffel to IRA From 1979 Through
1983 and to THC From 1984 Through 1986 (STJ report at
42-46)

William Schaffel (Schaffel) was a mortgage broker. In the

summer of 1979, Kanter, who was in New York City on other

unrelated business, contacted Schaffel and indicated he had a
 -108-

business proposition to present to him. Before this phone call

from Kanter, Schaffel had never met Kanter in person, and he had

spoken to Kanter only once on the phone several years earlier.

Schaffel, Transcr. at 379-380. Kanter invited Schaffel to meet

for further discussions over dinner at a New York City

restaurant. He further told Schaffel that Ballard and Lisle, two

friends of Kanter, 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, no business involving Prudential was

discussed by Kanter, Ballard, Lisle, and Schaffel. Although

Prudential business may not have been discussed at the dinner,

Lisle recognized that Kanter’s motivation for arranging the

dinner was to see whether Schaffel might be able to do business

with Prudential in the future. Exh. 2030, at 24. During the

dinner, Kanter asked whether Schaffel would be interested in

arranging the financing for a casino hotel to be built in

Atlantic City, New Jersey. Prudential was not involved in the

casino project. When Schaffel expressed interest, Kanter told

Schaffel that, in return for Kanter’s assistance to Schaffel in
 -109-

obtaining the contract to do the casino’s financing, Kanter would

have to receive 50 percent of Schaffel’s fees on the project.54

Although the Atlantic City casino project fell through,

Schaffel subsequently had substantial business dealings with

Prudential on behalf of certain individuals he represented.

These business dealings included construction contracts that he

helped obtain for Torcon, Inc. (Torcon), and financing for a

number of large commercial real estate properties being developed

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

Colorado.

After the dinner meeting with Kanter, Ballard, and Lisle,

Schaffel agreed to split with Kanter any brokerage fees that he

might earn on Prudential-related transactions. Schaffel,

Transcr. at 384-386. However, to protect his interests as a real

estate broker, Schaffel insisted that Kanter’s share of those

fees be paid to an individual or entity with a real estate

broker’s license. Schaffel, Transcr. at 393. Kanter in turn

directed Schaffel to make the payments to IRA, which held a

corporate real estate broker’s license through Schott, IRA’s

president at the time. Id.; Schott, Transcr. at 2119; Exh. 4022.

54
The reference in the STJ report to “Kanter and/or an
entity associated with Kanter” is manifestly unreasonable.
Schaffel’s testimony regarding the proposed casino project was
that Kanter himself expected to share in any fees that Schaffel
might earn on the deal. Schaffel, Transcr. at 383-386.
 -110-

As discussed in detail below, between 1979 and 1983,

Schaffel shared with IRA fees from business deals with

Prudential. Some of the fees Schaffel and IRA shared were

Prudential deals that took place after Ballard and Lisle had left

Prudential.

a. Sale of IBM Building

Shortly after the dinner meeting described above, Schaffel

participated as a real estate broker in a transaction involving

Prudential’s purchase of IBM, Inc.’s headquarters building in

Lexington, Kentucky. Schaffel, Transcr. at 390. Transatlantic

Group, a real estate brokerage based in Germany, approached

Schaffel and inquired whether Prudential might be interested in

purchasing the property. Id. Schaffel then arranged a meeting

among himself, Transatlantic Group, and Ballard at Prudential’s

headquarters in Newark. Id. After the meeting with Ballard, the

matter was referred to Prudential’s field office in Kentucky for

closing on Prudential’s purchase of the property. Id. Schaffel

split the brokerage fee on the transaction with Transatlantic

and then split his share of the fee with Kanter. Id. at 390-391.

b. Torcon Transactions With Prudential

Prior to 1979, Schaffel rented office space from Benedict

Torcivia (Torcivia), the sole shareholder of Torcon, which was

then perhaps the largest general contracting company in New
 -111-

Jersey. On or about July 24, 1979, Torcivia agreed to pay Mr.

Schaffel a 1-percent fee for any construction work that Schaffel

was “able to help Torcon obtain.” Exh. 185; Torcivia, Transcr.

at 361-362. On August 2, 1979, in connection with the Torcivia

agreement, Schaffel signed an agreement with IRA which stated:

The purpose of this letter is to confirm that I
will pay to 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
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. [Exh. 186].

As previously discussed, Schaffel entered into this agreement

with IRA only because Kanter identified IRA as an entity that

held a corporate real estate brokerage license, which appeased

Schaffel’s concerns about sharing brokerage fees with someone

other than a licensed real estate broker.

After 1979, Torcon was awarded Prudential construction

contracts referred to as the Parsippany Business Campus,

Parsippany Hilton Hotel, Gateway Office Complex, and Princeton

Interplex Complex. Torcivia, Transcr. at 362. Torcivia met

Lisle at the groundbreaking for the Parsippany Hilton Hotel in

1980. Torcivia, Transcr. at 363-364.
 -112-

c. Walters’s Transactions With Prudential

Walters was a commercial real estate developer who did most

of his business in Colorado and Texas. Walters, Transcr. at 314-

315. On October 19, 1981, Walters and Schaffel entered into two

written agreements which provided that Schaffel would receive

fees ranging from 1.75 to .875 percent of the aggregate permanent

financing that Walters received from Prudential with regard to

completed development projects referred to as the Ramada

Renaissance and Cherry Creek Place II. Exh. 189 (Ramada

Renaissance); Exh. 190 (Cherry Creek Place II). The agreements

included an acknowledgment that Prudential provided the financing

primarily as a result of Schaffel’s efforts. Id. Before

finalizing these transactions, Walters met with Ballard at

Prudential’s Newark headquarters. Walters, Transcr. at 317-319.

On November 5, 1981, Barbara DiLanciano sent a letter to

Schaffel, on behalf of IRA, regarding the Ramada Renaissance and

Cherry Creek Place II development projects, which stated: “this

letter will serve as your notification and restatement of our

arrangement wherein * * * [IRA], as your broker, is to receive

one-half of the financing fee due you.” Exh. 471. Prudential

committed to provide $17 million and $15.6 million in financing

for the Ramada Renaissance and Cherry Creek Place II projects,

respectively. Exhs. 189, 190.
 -113-

d. Walters’s Transactions With Travelers

Lisle left Prudential in April 1982 and thereafter was

employed at Travelers until April 1988. Exh. 2030, at 1.

Schaffel eventually had substantial business dealings with

Travelers on behalf of individuals he represented. A number of

these business deals involved Travelers’ financing of various

real estate projects at Denver, Colorado, being developed by

Walters. Shortly after Lisle began working at Travelers,

Schaffel met and renewed his acquaintance with Lisle, and they

resumed the business relationship relating to real estate

development financing they had established at Prudential.

Schaffel, Transcr. at 394-395.

On December 12, 1982, Walters and Schaffel entered into two

written agreements which provided that Schaffel would receive

fees of 1 percent of the aggregate financing that Walters

obtained from Travelers with regard to development projects

referred to as Cherry Creek National Bank and Stanford Place II.

Exh. 195 (Cherry Creek National Bank); Exh. 196 (Stanford Place

II). The Walters/Schaffel fee agreement pertaining to Cherry

Creek National Bank was printed on Kanter & Eisenberg law

partnership letterhead. Exh. 195.

In November 1983, Walters and Schaffel entered into four

additional written fee agreements which provided that Schaffel
 -114-

would receive a fee of 1 percent of the aggregate financing that

Walters obtained from Travelers with regard to four separate

development projects. Exh. 193 (17th & Market Plaza); Exh. 197

(Orchard Place VIII); Exh. 198 (Orchard Place VII); Exh. 199

(Cherry Creek Building III). The record reflects that Lisle

personally approved Travelers financing for several of these

development projects. Exhs. 990, 993, 995.

By check dated November 9, 1983, Schaffel paid $213,750 to

IRA representing 50 percent of the fees that Schaffel earned on

the Stanford Place II project.55 Exh. 204, at 2. After the

Stanford Place II payment, however, Schaffel stopped paying IRA

on Travelers transactions, and a dispute with Kanter followed.

Sometime during 1984, Kanter contacted Schaffel and inquired

why IRA was not receiving 50-percent of Schaffel’s fees on

Travelers deals. Schaffel took the position that the August 2,

1979, agreement between himself and IRA did not apply to deals

with Travelers because Lisle had left Prudential. Schaffel was

concerned that the terms of his agreement with IRA were too

comprehensive and costly. Schaffel explained: “Bob [Lisle] had

moved on to Travelers and Claude [Ballard] had moved on to

55
Thus, the recommended finding of fact in the STJ report,
at 44, that Schaffel initially did not share with IRA the fees he
earned on business deals with Travelers is incorrect as to the
fee from the Stanford Place II project.
 -115-

Goldman Sachs and I was no more dealing with The Prudential.”

Schaffel, Transcr. at 395. However, Kanter disagreed and

maintained the August 2, 1979, agreement continued to apply.

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

stated, in pertinent part:

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.

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.

Kanter’s letter reveals that he believed Schaffel was obliged to

remit payments to IRA if Schaffel obtained any business from

Ballard or Lisle wherever they might be employed. Exh. 200.

Lisle also discussed with Schaffel the dispute between

Schaffel and Kanter.56 Although Lisle indicated that he did not

56
The recommended findings of fact adopted from the STJ
report relating to Schaffel’s discussions with Lisle are drawn
solely from Schaffel’s testimony on the subject. Schaffel,
Transcr. at 396. Lisle stated that he had no recollection of any
contacts from Schaffel or Kanter regarding the fee dispute
(continued...)
 -116-

care about any arrangement between Schaffel and Kanter and did

not want to become involved in their apparent dispute, Lisle

expressed concern about a possible lawsuit being brought, and

such a lawsuit might cause some difficulty for Lisle at

Travelers.

Schaffel and Kanter eventually settled the dispute by

agreeing that (1) Schaffel was obliged to share fees with Kanter

only if he did business with Travelers, and (2) those fees would

be remitted to a new Kanter-related entity, THC. From 1984

through 1986, pursuant to the agreement, Schaffel paid a share of

his fees on business deals with Travelers to THC. Schaffel,

Transcr. at 396-399; Exh. 203; Exh. 206, at 1. The record does

not reflect the identity of the THC officer who held a real

estate broker’s license.

e. Schaffel’s Payments to IRA and THC

From 1979 to 1983, Schaffel paid $1,184,876 to Kanter (by

checks made payable to IRA) representing 50 percent of the

fees Schaffel received for (1) arranging Prudential construction

contacts for Torcon, and (2) obtaining Prudential financing for

Walters’s projects, as set forth in the following table.

56
(...continued)
described above. Exh. 2030, at 21, 23.
 -117-

Table 5

Amount Exhibits

$100,000 204, at 2; 10, at 15, l. 10
244,920 12, at 25, statement 35
361,525 14, at 6; Kuck, Transcr.
at 3375-3377
447,450 17, at 16 “general fee”
30,981 204, at 1
1,184,876

From 1983 to 1986, Schaffel paid $2,977,250 to Kanter (by

checks made payable to IRA and THC) representing 50 percent of

the fees that Schaffel received for obtaining Travelers financing

for Walters’s projects, as set forth in the following table.

Table 6

Date Walters’s Project IRA THC Exhibit

11-9-83 Stanford Place II $213,750 -- 204, at 2
10-30-84 Orchard Place VII -- $85,000 206, at 1
10-30-84 Orchard Assoc. III -- 15,000 206, at 2
10-30-84 17th & Market Assoc. -- 300,000 206, at 3
12-10-84 Stanford Corp. Ctr. -- 200,000 206, at 4
1-23-85 Stanford Corp. Ctr. -- 60,000 206, at 5
9-3-85 Connecticut Plaza -- 1,100,000 206, at 6
4-21-86 Stanford Corp. Place -- 440,000 206, at 7
11-19-86 Boston Building -- 123,500 206, at 8
12-8-86 Travelers Train. Ctr. -- 440,000 208, at 3
Total 213,750 2,763,500

Schaffel, Transcr. at 416-417, 422; Petitioners’ Reply Brief at

314.

There is no evidence in the record that anyone representing

or acting on behalf of IRA or THC was “instrumental or helpful”

in obtaining financing from Prudential or Travelers for Walters’s
 -118-

development projects or in arranging Prudential construction

contracts for Torcon.

f. Four Ponds, FPC Subventure, and One River Partnerships

Kanter and Lisle invested in two real estate development

projects that Schaffel and Torcivia were instrumental in

organizing. Each development project was undertaken by a limited

partnership. One project was through the One River Associates

Limited Partnership (One River Partnership); the other project

was through the Four Ponds Associates Limited Partnership (Four

Ponds Partnership).

(i). Four Ponds Partnership

On or about March 21, 1980, Torcivia and Schaffel, as

general partners, along with Kanter and other limited partners,

formed the Four Ponds Partnership. Exh. 187. Four Ponds

Partnership was formed to acquire real estate located in

Middletown, New Jersey, and to construct an office building on

the property. Id.; Schaffel, Transcr. at 402-404. Torcivia and

Schaffel each acquired a 30-percent general partnership interest

in Four Ponds Partnership, and Kanter acquired an 8-percent

limited partnership interest. Exh. 213; Torcivia, Transcr. at

369-370; Exh. 9093; Exh. 187, par. 3.1. Lisle was not a direct

partner in Four Ponds Partnership. Exh. 187.
 -119-

(ii). FPC Subventure Partnership

On January 1, 1981, the FPC Subventure Partnership was

formed. Exh. 188. The partners of FPC Subventure Partnership

were:

Percentage
Partner Interest

Robert Lisle 90.0
Everglades Trust I, Roger Baskes Trustee 1.8
Everglades Trust II, Roger Baskes Trustee 1.8
Everglades Trust III, Roger Baskes Trustee 1.8
Everglades Trust IV, Roger Baskes Trustee 1.8
Everglades Trust V, Roger Baskes Trustee 1.8
Burton W. Kanter Revocable Trust, Burton 1.0
W. Kanter, Trustee _____
Total 100.0

Exh. 188, at 1, 11; Exh. 9091. Although the partnership

agreement for FPC Subventure Partnership called for Lisle to make

a $2,880 cash contribution to the partnership, Lisle did not

recall making a capital contribution, and he believed

(incorrectly) that he made a small investment directly in the

Four Ponds Partnership. Exh. 2030, at 33.

(iii). One River Partnership

On November 16, 1981, Torcivia and Schaffel, as general

partners, along with Kanter and other limited partners, formed

the One River Partnership. Exhs. 986, 211. One River

Partnership was formed to acquire real estate located in

Middletown, New Jersey, and to construct an office building and
 -120-

hotel on the property. Exh. 986; Schaffel, Transcr. at 404-405.

Torcivia and Schaffel each acquired a 36-percent general

partnership interest in One River Partnership, and Kanter held an

8-percent limited partnership interest. Exh. 986, sch. A. Lisle

was not a direct partner in One River Partnership. Id. Kanter

made a $2,000 capital contribution to One River Partnership. Id.

(iv). Meyers’s Memorandum Regarding Four Ponds Partnership

A “memorandum to file” (apparently prepared by Meyers),

dated April 14, 1982, stated that (1) although Kanter purportedly

acquired a limited partnership interest in Four Ponds Partnership

as a nominee, Kanter reported partnership items for Four Ponds

Partnership for the taxable year 1980 on his personal tax return,

(2) on January 1, 1981, Kanter (as nominee) transferred his 8-

percent limited partnership interest in Four Ponds Partnership to

Lisle (90 percent) and the Everglades Trusts (10 percent);57 (3)

Lisle issued a promissory note to Kanter for $2,880; (4) Lisle

and the Everglades Trusts formed the FPC Subventure Partnership;

(5) the 8-percent Four Ponds limited partnership interest

57
Contrary to this statement in the memorandum, FPC
Subventure’s tax return for 1981 indicated the five Everglades
Trusts initially each acquired 1.8-percent limited partnership
interests (for a total of 9 percent) and Kanter acquired a 1-
percent limited partnership interest. Exh. 9091. By 1982, FPC
Subventure’s tax returns indicated the five Everglades Trusts
each held 2-percent limited partnership interests. Id.
 -121-

constituted a capital contribution to FPC Subventure Partnership,

and (6) Four Ponds Partnership made a $400,000 cash distribution

to Kanter on April 5, 1982, and Kanter transferred the

distribution to FPC Subventure Partnership, which distributed

$355,500 to Lisle and $39,500 to the Everglades Trusts, leaving

$5,000 in FPC Subventure Partnership’s account. Exh. 9093.58

On May 3, 1982, Kanter wrote a letter to Schaffel which

stated in pertinent part:

The purpose of this letter, as we discussed, is to
reflect the fact that I have been holding a partnership
interest in Four Ponds Center Associates in my name on
behalf of another partnership, known as FPC Subventure
Associates. There are two participants in that
partnership, trusts for the benefit of members of my
family and associates. [Exh. 194.]

The letter also stated that the Four Ponds partnership agreement

would not need to be modified so long as Kanter continued to hold

the partnership interest in his name. Id. Schaffel and Torcivia

were not aware Lisle was a partner in FPC Subventure Partnership.

Schaffel, Transcr. at 407; Torcivia, Transcr. at 371.

In 1982, Kanter transferred his 8-percent limited

partnership interest in One River Partnership to FPC Subventure

58
Contrary to this statement in the memorandum, FPC
Subventure’s tax return for 1982 indicated the partnership made a
cash distribution of $427,600, and a Schedule K-1, Partner’s
Share of Income, Deductions, and Credits, issued to Lisle
indicated he received $384,840 (or 90 percent) of that amount.
Exh. 9091.
 -122-

Partnership in exchange for a promissory note of $2,000. Exh.

915.

(v). FPC Subventure’s Tax Returns

During the years at issue, Kanter and Lisle reported their

distributive shares of FPC Subventure’s partnership items of

income, loss, deduction, and credit.59 Exhs. 125-134 (Kanter);

59
On June 13, 1994, at the start of the trial in these
cases, respondent filed an amendment to answer seeking increased
deficiencies and additions to tax for fraud. Included in
respondent’s amendment to answer were allegations that Lisle was
not entitled to deduct losses related to FPC Subventure
Partnership because he never made a capital contribution to the
partnership (and, thus he was not a partner in the partnership)
and/or Lisle was not “at risk” within the meaning of sec. 465.
On June 13, 1994, Lisle filed a reply to respondent’s amendment
to answer. On July 26, 1994, Lisle filed a motion to strike
portions of respondent’s amendment to answer. Specifically,
Lisle moved to strike the portion of respondent’s amendment to
answer pertaining to FPC Subventure Partnership on the ground the
transaction “does not relate to ‘The Five’ in any way.” Lisle
further alleged that respondent’s attempt to raise the FPC
Subventure Partnership issue amounted to an attempt to use the
trial as an ongoing audit. On July 28, 1994, respondent filed an
objection to petitioners’ motion to strike and alleged that FPC
Subventure Partnership was directly related to The Five as
demonstrated by Schaffel’s testimony during the first phase of
the trial.

On July 28, 1994, the Court heard oral argument regarding
Lisle’s motion to strike. Transcr. at 3060-3096. On July 28,
1994, Special Trial Judge Couvillion granted Lisle’s motion to
strike insofar as respondent was seeking increased deficiencies
attributable to FPC Subventure Partnership.

Given that petitioners’ motion to strike was granted, the
FPC Subventure Partnership transactions will not increase the
amounts of Lisle’s tax liabilities for the years remaining at
issue. Nevertheless, our review of the record reveals that FPC
Subventure Partnership is highly relevant to respondent’s theory
that Kanter, Ballard, and Lisle earned the payments remitted by
(continued...)
 -123-

417-421 (Lisle). The record shows that Four Ponds Partnership

and One River Partnership (1) reported net losses in 1981 to 1984

and 1987 to 1989 totaling $1,067,131, and (2) made cash

distributions to its partners in 1981 to 1984 and 1987 to 1989

totaling $731,080. Respondent’s Opening Brief at 349-350, par.

1016, and Petitioners’ Reply Brief at 663-664; Exhs. 125-134

(Kanter); Exhs. 417-421 (Lisle); Exhs. 9090-9094 (FPC Subventure

Partnership tax returns and Schedules K-1 for Four Ponds

Partnership and One River Partnership). Approximately 7 percent

of Four Ponds’ and One Rivers’ partnership losses, described

above, flowed through to Lisle through FPC Subventure

Partnership. Exhs. 417-421.

Tax effects aside, during the period 1981 to 1989 Lisle

received at least $682,520 in cash distributions from FPC

Subventure Partnership.60 Exhs. 9090-9094, 417-421.

Consequently, FPC Subventure Partnership served for Lisle the

dual purposes of (1) a tax shelter, and (2) a source of

substantial cashflows.

59
(...continued)
The Five to IRA and THC. As discussed in additional findings of
fact in the text that follows, we are convinced Kanter used FPC
Subventure Partnership as a conduit to facilitate the transfer to
Lisle of his share of fees that Schaffel paid to THC on Travelers
transactions.
60
FPC Subventure Partnership’s tax returns for 1985 and
1986 apparently were not made part of the record.
 -124-

4. Schnitzer/PMS Payments From 1979 Through 1989 (STJ
report at 46-49)

During the 1960s and 1970s, Kenneth Schnitzer (Schnitzer)

was a major real estate developer in the Houston, Texas, area.

Schnitzer met Ballard and Lisle at Prudential’s Houston regional

office in the late 1960s. Schnitzer, Transcr. at 2153.

In 1974, Century Development Corp. (Century), a subsidiary

of Century Corp., Schnitzer’s family holding company, acquired

for a price of $1.2 million a small real estate management

company called Fletcher Emerson Co., Inc., whose name shortly

thereafter was changed to Property Management Systems, Inc.

(PMS). Ross, Transcr. at 1213-1214.61 Previously, Schnitzer had

been involved in developing and managing high-rise office

buildings through Century. By acquiring PMS, Century expected to

diversify its operations and to secure a steady source of

earnings, because the real estate development business it also

engaged in typically was cyclical.

When Century purchased PMS in 1974, the purchase price of

$1.2 million was based roughly on five times PMS’s pretax

earnings of approximately $250,000. Ross, Transcr. at 1169,

1172; Schnitzer, Transcr. at 2149. Walter Ross (Ross) was a

61
Fletcher Emerson was purchased by a subsidiary of
Century Development Corp. known as E.R.K. Enterprises, Inc. Exh.
278, tab 6.
 -125-

C.P.A. and senior vice president of finance at Century when it

purchased PMS. Ross, Transcr. at 1166. In 1974, Ross became

president of Century Corp. Id. at 1165. According to Ross, it

was customary in the industry to base the purchase price of a

service corporation such as PMS on a multiple of the firm’s

pretax income. Id. at 1172-1173.

Originally, PMS’s property management business was almost

all in Texas, principally Houston and Dallas. PMS typically

managed office buildings and other commercial real estate owned

by others under property management contracts on a month-to-month

basis. As of the time of PMS’s 1974 acquisition by Century,

although Prudential was perhaps PMS’s biggest customer, PMS

managed a relatively small number of Prudential’s commercial real

properties. Shortly after Century acquired PMS, Schnitzer

attempted to expand substantially the size of PMS’s property

management business, as PMS typically earned only a relatively

modest profit margin on its individual property management

contracts. Schnitzer felt that the only way to increase PMS’s

profits was having a large volume of such management contracts.

To that end, in 1974, Schnitzer approached Ballard (who

Schnitzer had previously dealt with in developing office

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

Prudential a 50-percent stock interest in PMS. Although
 -126-

Prudential would not be paying anything for the 50-percent PMS

stock interest, Schnitzer hoped that this would result in

Prudential’s awarding PMS a large number of additional property

management contracts. Ballard informed his superiors at

Prudential of Schnitzer’s offer.

Initially, Prudential was interested in Schnitzer’s offer.

Schnitzer was invited to Prudential’s Newark, New Jersey,

corporate headquarters for further meetings and discussions with

Prudential’s management. Schnitzer met with Prudential’s senior

executives and corporate headquarters staff, including

Prudential’s chairman, and with Donald Knab (who headed

Prudential’s real estate department). Prudential was

particularly interested in standardizing the reports it received

on the operating results of its various commercial real

properties around the country. However, Prudential ultimately

declined Schnitzer’s offer, because of the substantial number of

pension plans whose real estate investment accounts Prudential

managed. Prudential believed that having an ownership interest

in PMS might be a potential conflict of interest and might

present problems under the pension laws.

Although Prudential declined Schnitzer’s offer, from 1974

through late 1977, PMS’s property management business increased

substantially, with Prudential being PMS’s biggest customer.

Pursuant to Schnitzer’s discussions with Prudential’s management
 -127-

and corporate headquarters staff in 1974, PMS standardized its

reports on the Prudential commercial real properties that PMS

managed. By 1977, PMS had expanded its property management

operations to other cities around the country, including Atlanta,

Georgia; Los Angeles and San Francisco, California; Newark, New

Jersey; and Portland, Oregon.

Ballard introduced Schnitzer to Kanter at an Urban Land

Institute meeting in Hawaii in the mid 1970s. Schnitzer,

Transcr. at 2161-2164. In 1977, Schnitzer and Kanter discussed

Century’s possible sale of a 47.5-percent stock interest in PMS

to IRA. Kanter indicated that, through Kanter’s business

contacts, Kanter could obtain additional property management

business for PMS with other parties, including possibly with the

Pritzker family.62

In November 1977, Century sold a 47.5-percent stock interest

in PMS to IRA for $150,000. The sale was made subject to

Century’s right to apply PMS’s profits first to servicing the

$1.1 million debt Century had incurred to purchase PMS in 1974.

62
The statement in the STJ report referring to “Kanter
and/or IRA” is manifestly unreasonable. Schnitzer testified that
Kanter suggested he could obtain additional business for PMS.
Schnitzer, Transcr. at 2167. There is no credible evidence that
anyone other than Kanter provided additional business
opportunities for Schnitzer/PMS.
 -128-

IRA paid $50,000 at closing and issued a promissory note to PMS

for the $100,000 balance. Exhs. 240, 241; Ross, Transcr. at

1200.

Schnitzer conferred with Ballard before agreeing to sell

PMS’s common stock to IRA. Schnitzer, Transcr. at 2166-2167.

Schnitzer was content to sell PMS common stock to IRA at a

bargain price in exchange for Kanter’s promise to attempt to use

his business contacts, including his relationship with the

Pritzker family, to obtain more real estate management contracts

for PMS. Schnitzer, Transcr. at 2167. Ross shared Schnitzer’s

view that PMS’s common stock was sold to IRA at a bargain price

in expectation that Kanter would use his many contacts to

generate business for PMS. Schnitzer, Transcr. at 2170-2171;

Ross, Transcr. at 1182, 1195, 1201.

Schnitzer and Ross were not relying on IRA, Schott, or

Weisgal to generate additional business opportunities for PMS.

Schnitzer and Ross were relying solely on Kanter to obtain

additional business opportunities for PMS. Ross, Transcr. at

1195, 1201.

During the period 1976 to 1979, PMS obtained a growing

number of management contracts from Prudential. Schnitzer,

Transcr. at 2173. During the period 1976 to 1979, approximately

40 percent of PMS’s revenue was derived from Prudential property
 -129-

management contracts. Exh. 977, at 10; Ross, Transcr. at 1188.

By the end of 1979, PMS’s revenues had tripled from 1974 when

Century bought PMS for $1.2 million. Exh. 977, at 4; Exhs. 750,

964. PMS’s gross income from 1976 to 1980 was:

Year Gross Income Exhibit

1976 $3.4 million 5751
1977 4.3 million 278, tab 4
1978 6.0 million 963
1979 7.7 million 964
1980 9.6 million 965

PMS’s pretax earnings for 1976 through 1978 were $317,615,

$451,058, and $831,828, respectively. Exh. 278, tab 14.

In March 1979, Kanter brought to Schnitzer’s attention a

potentially large property management opportunity. Exhs. 259,

260. Nevertheless, in late March 1979, Schnitzer informed Kanter

he was disappointed that Kanter had failed to produce the

additional property management business for PMS that had been

expected. Schnitzer decided Century should purchase IRA’s

47.5-percent PMS stock interest. Exh. 262. Kanter suggested he

might make a counteroffer to purchase Century’s remaining shares

in PMS. Exh. 263; Schnitzer, Transcr. at 2175. By letter dated

July 17, 1979, Kanter proposed that IRA would purchase PMS’s

remaining shares for $3.1 million to be paid in installments over

10 years. Exh. 268. On August 1, 1979, Schnitzer and Kanter

agreed that Century would purchase the PMS stock held by IRA for
 -130-

a price of $3.1 million, to be paid to IRA over 10 years with

interest. Exh. 270.

In February 1989, Kanter wrote to Ross and inquired whether

PMS would be interested in making an early, discounted final

payment on the PMS stock repurchase agreement. Exh. 344. Kanter

mentioned in his letter that IRA had assigned its contract rights

under the IRA/PMS installment agreement and that any payment

should be remitted to PSAC, Inc., which served as the depository

for the assignee. Id. The record reflects that PMS accepted

Kanter’s proposal and remitted a final payment of $750,000 to

PSAC in February 1989, and the payment was distributed to Carlco,

TMT, and BWK, as discussed below. Exh. 345.

During the period 1979 to 1989, PMS made installment

payments to IRA as set forth in the following table.
 -131-

Table 7

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

Exhs. 281, 284-346; Exhs. 14, 17, 18-24 (IRA tax returns).63

5. Payments From Eulich/Essex Partnership to IRA and THC
From 1982 Through 1989 (STJ report at 49-59)

a. John Eulich

John Eulich (Eulich) was a real estate developer of office

buildings, shopping malls, and warehouses in Houston and Dallas,

Texas. In connection with his real estate development work,

Eulich had known Ballard and Lisle since at least 1965, when

Ballard and Lisle worked in Prudential’s Houston regional office.

A.N. Pritzker introduced Eulich to Kanter at the opening of a

Hyatt hotel in the late 1960s or early 1970s. Eulich, Transcr.

at 1617-1618.

63
Some of the quarterly checks that PMS remitted to IRA
were not included in the record.
 -132-

Eulich’s real estate development activities were primarily

conducted through Vantage, Inc., a corporation that he owned. In

addition, Eulich later became a majority shareholder in Motor

Hotels Management, Inc. (MHM). During some of the years at

issue, MHM, IRA, THC, and Gateway Hotel Management Corp. were

partners in the Essex Partnership, which partnership is discussed

more fully below.

In 1968, Eulich acquired Rodeway Inns, a company that owned

a small chain of garden court motels. Over the years, Rodeway

Inns increased the number of its motels. In acquiring many of

Rodeway Inn’s additional motels, Rodeway Inns and Eulich obtained

financing from Prudential. From 1968 through about 1973, in

securing this financing for Rodeway Inns, Eulich dealt with

Ballard. In about 1974, Eulich and Prudential became

dissatisfied with the performance of the hotel management company

that was managing and operating some 16 Rodeway Inns motels that

had been financed by Prudential.

Eulich decided to establish his own hotel management

company, MHM, to operate the motels. Eulich arranged to have

Robert James (James), who had substantial hotel management

experience, serve as MHM’s president and manage MHM’s day-to-day

operations. MHM was incorporated on January 1, 1975. MHM’s

three shareholders eventually included Eulich (who was the
 -133-

majority shareholder), James, and another longtime business

associate, C. Huston Bell.

In persuading James to participate in the ownership and

operation of MHM, it was agreed that MHM’s hotel management

business would be expanded. After MHM commenced its operations,

although he generally was not involved in conducting MHM’s

day-to-day business operations, Eulich helped arrange financing

for MHM and was actively engaged in marketing MHM’s services to

various outside parties in an effort to obtain additional hotel

management business.

By the middle to late 1970s, MHM had acquired a good

reputation for the hotel management services it offered.

Prudential’s real estate department staff generally were very

satisfied with MHM’s management of a number of hotel properties

in which Prudential was involved. However, until about the early

1980’s, MHM generally only managed smaller-size hotel properties,

not large hotels. By about the early 1980s, MHM managed hotel

properties nationwide in about 20 to 25 states, although to a

more limited and lesser extent than it wished in the northeastern

region of the country.

b. Allen Ostroff

In about 1976, Allen Ostroff became a Prudential real estate

department employee and served as Prudential’s in-house

consultant on hotels and hotel operations. Prior to joining
 -134-

Prudential, Ostroff had worked for a number of years for Hilton

Hotels as a hotel manager and executive. Ballard was

instrumental in Prudential’s hiring of Ostroff, as Ballard had

concluded that Prudential’s real estate department needed to

employ an individual possessing substantial expertise in hotels

and hotel operations.

Previously, the real estate department staff in Prudential’s

regional offices negotiated hotel management contracts for

Prudential’s hotel properties on an ad hoc basis. By 1979,

Ostroff had devised a model hotel management contract that

Prudential’s real estate department staff could use in

negotiating such management contracts. Ostroff also worked on

various hotel projects for Donald Knab, Ballard, and/or Lisle.

c. Hotel Management Industry Trends

At some point during the 1970s, the hotel management

industry began to offer owners of large hotels relatively short-

term management contracts for hotels, typically for terms ranging

from 5 to 10 years. It was sometimes not desirable for a hotel

owner to enter into a long-term management contract, particularly

if the owner contemplated selling the hotel within the next 5 to

10 years, as an outstanding long-term management contract could

make the hotel more difficult to sell. Rather than entering into

a long-term management contract with a national hotel company,

like Hilton Hotels, Hyatt Corp., or Marriott Hotels, an owner of
 -135-

a large hotel frequently had its hotel operated under a franchise

with a national hotel company like Hilton Hotels or Marriott

Hotels.64 For instance, under a franchise agreement with Hilton

Hotels, the hotel owner could obtain the right to use the Hilton

name as well as the services of the Hilton national hotel

reservation system. The hotel owner then could have its Hilton-

franchised hotel managed and operated under a short-term

management contract with either Hilton Hotels (the franchisor) or

another hotel management company.65

d. The Gateway Hilton and John Connolly

Beginning in 1976, one of Ostroff’s first assignments at

Prudential was to improve the operating condition of the Gateway,

a hotel at Newark, New Jersey. The Gateway was located a few

blocks from Prudential’s corporate headquarters. The hotel was

shabby, as Prudential had recently acquired it through

foreclosure. Moreover, the class or type of customers that prior

operators of the hotel catered to was not the type of clientele

Prudential was comfortable with because other Prudential

64
During the period relevant to these cases, Hyatt Corp.
did not offer such franchise arrangements.
65
A hotel management executive testified that a national
hotel company, like Hilton Hotels, could not grant a hotel
franchise to a hotel owner conditioned upon the owner’s also
entering into a management contract with it for the franchised
hotel, as such action might violate the antitrust laws.
 -136-

executives and individuals transacting business at Prudential’s

headquarters office frequently stayed at the hotel.

Ostroff first obtained a Hilton franchise for the Gateway.

Although Hilton Hotels had been reluctant to grant Prudential a

franchise, Ostroff obtained the franchise by pointing out to

Hilton Hotels the other profitable business dealings it had with

Prudential.

Ostroff next hired another hotel management company to take

over the Gateway Hilton’s management and operation. This

management company was owned by Stanley Cox (Cox), an experienced

hotel manager Ostroff had known during Ostroff’s prior employment

with Hilton Hotels. At some point, Cox assigned John Connolly

(Connolly) to be the Gateway Hilton’s onsite manager. Ostroff

was extremely successful in turning around and substantially

improving the Gateway Hilton’s operating condition. Prudential

corporate headquarters executives eventually were proud to have

other Prudential executives and business visitors stay at the

hotel. Prudential executives also made significant use of the

hotel facilities for meetings and entertainment and were very

pleased with the service that they and their guests received at

the hotel.

Cox did not spend much of his own time actually running the

Gateway Hilton. Over the years, Cox delegated more and more

duties in the hotel’s operation to Connolly. In 1981, Connolly
 -137-

was dissatisfied living in Newark and requested that Cox transfer

him to another hotel that Cox managed in Atlanta. Connolly,

Transcr. at 2623.66 Although Cox granted Connolly’s request,

Ostroff wanted Connolly to stay at the Gateway Hilton, and he

approached Cox with a proposal to transfer the Gateway Hilton

management contract to Connolly and give Cox another management

contract at a different hotel. Connolly, Transcr. at 2623-2624.

Ostroff and his superiors at Prudential then decided to terminate

Prudential’s management contract with Cox and awarded the

management contract to a hotel management company owned by

Connolly.67

Ostroff advised Connolly of Prudential’s desire to have him

manage the Gateway Hilton; however, Ostroff advised Connolly that

he would have to establish a management company of his own

because Prudential did not want to have its employees involved in

operating the hotel and did not want any of the hotel’s employees

to be Prudential employees. All hotel employees would have to be

66
The STJ report, at 54, incorrectly recommended as a
finding of fact that “Connolly informed Ostroff that he was
considering leaving his position as onsite manager of the Gateway
Hilton, because he felt he was not being adequately compensated
for his services.”
67
This recommended finding of fact is manifestly
unreasonable. As discussed in additional findings of fact, see
infra pp. 138-144, John Connolly (Connolly) continued to manage
the Gateway Hilton, but he neither organized nor operated a hotel
management company.
 -138-

employees of Connolly’s hotel management company. However,

establishing such a hotel management company presented a problem

for Connolly, as Connolly’s management company, among other

things, would be required to employ a financial manager and an

accounting staff to prepare and issue the financial reports on

the Gateway Hilton’s operations that Prudential expected.

Moreover, its full-time employment of such personnel to perform

these and other required services could well be uneconomical, as

Connolly’s company would be managing only one or at most two

hotels. As discussed in detail below, Kanter and Eulich provided

a solution to assist Connolly in managing the Gateway Hilton.

e. Gateway Hotel Management Co. and Essex Corp.

As previously mentioned, Eulich wanted MHM’s hotel

management business eventually to include MHM’s management of a

number of large hotels. Eulich previously knew Kanter from being

involved in certain prior business ventures in which Kanter had

helped raise capital. He believed that Kanter’s business

contacts, particularly those contacts attributable to Kanter’s

association with the Pritzker family, could be beneficia1 to MHM,

as Kanter knew many people in the hotel industry, including

individuals who owned the large hotels that MHM wanted to manage.

From Eulich’s perspective, an association with Kanter would be

beneficial if MHM could obtain one hotel management contract for
 -139-

a large hotel through Kanter’s efforts. Eulich, Transcr. at

1647-1648.

Kanter and Eulich were aware Connolly would need assistance

organizing a hotel management company for the Gateway Hilton.

Ballard was also aware of Connolly’s needs, and he introduced

Eulich to Connolly as someone who would assist Connolly with the

support services he needed to properly manage the Gateway Hilton.

Connolly, Transcr. at 2620-2621, 2631. Ballard believed Connolly

also met with Kanter. Ballard, Transcr. at 184. As discussed

below, Eulich (probably with Kanter’s assistance) organized

Gateway Hotel Management Co. (GHM) for Connolly.68

In 1981, Eulich and Kanter organized a corporation called

Essex Hotel Management Co. (Essex Corp.). Formby, Transcr. at

1502-1503; Eulich, Transcr. at 1650; Clifford, Transcr. at 1669-

1670. By letter dated October 16, 1981, Eulich informed Connolly

that (1) GHM had been organized, (2) GHM was capitalized with

$10,000, and (3) Connolly would be expected to pay $2,000 to

Eulich from GHM’s first distribution to cover his share (20

68
The STJ report, at 55, included a recommended finding of
fact that “Mr. Connolly, nevertheless, proceeded to organize a
hotel management company and incorporated Gateway Hotel
Management Corp. (GHM) some time in 1981.” This recommended
finding of fact is manifestly unreasonable. As discussed in the
Court’s additional findings of fact in the text that follows,
John Connolly did not organize a hotel management company, and he
was largely ignorant of the existence and function of the various
business entities with which he was associated.
 -140-

percent) of GHM’s capitalization. Exh. 691.69 It appears,

however, the arrangement described above was not carried out

because, on March 2, 1982, Connolly and Essex Corp. executed an

option agreement (the GHM option agreement), which they

purportedly had agreed to on September 18, 1981, which recited

that Connolly owned 100 percent of GHM, Connolly was transferring

to Essex Corp. an option to acquire 80 percent of GHM (80 shares

at $100 per share) for 10 years and, in exchange for the option,

Essex Corp. would pay Connolly $1,000 per year for 10 years.

Exh. 817. The record also includes an $8,000 promissory note,

dated December 15, 1981, from Connolly to Essex Corp. (the

Connolly promissory note) requiring annual payments for 9 years

and a final balloon payment in 1991. Exh. 4015.70

f. MHM and GHM Hotel Management Contracts

In October 1979, MHM was awarded a management contract for a

new hotel being constructed on Madison Avenue in Morris Township,

New Jersey (the Madison Hotel). Exh. 688. In February 1980,

Prudential provided financing for this hotel. Exh. 1010. In

August 1981, MHM also began managing a newly opened Hilton Hotel

69
Eulich had no recall of these matters at trial. Eulich,
Transcr. at 1649-1650.
70
The $8,000 amount apparently represents the balance of
the $10,000 initial capitalization of Gateway Hotel Management
Co. (GHM) (assuming Connolly paid $2,000 to Eulich in accordance
with the Oct. 16, 1981, letter described above).
 -141-

in Allentown, Pennsylvania (the Allentown Hilton). Clifford,

Transcr. at 1667.

In late 1981, GHM received from Prudential a management

contract to operate the Gateway Hilton, and, in February 1982,

GHM received a management contract to operate another Hilton-

franchised hotel that Prudential owned at Midland, Texas (the

Midland Hilton).71 Exh. 695. Eulich believed Kanter assisted

MHM and Essex Partnership in obtaining the management contract

for the Gateway Hilton. Eulich, Transcr. at 1634. Eulich’s

testimony on this point is revealing. In short, Eulich

considered the Gateway Hilton management contract to fall within

MHM’s portfolio of contracts (even though the contract

technically was awarded to Connolly/GHM) because MHM’s employees

provided all the essential services required to manage the hotel.

g. Essex Partnership

Essex Hotel Management Co. (Essex Partnership) was formed on

January 1, 1982, and apparently was intended to supplant Essex

71
Although Ostroff and Prudential ultimately awarded the
Midland, Texas, hotel’s management contract to GHM, GHM and MHM
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. Ballard and Lisle were aware
Connolly was awarded the Gateway Hilton management contract, and
Lisle was aware Connolly was awarded the Midland Hilton
management contract. Exh. 695; Ballard, Transcr. at 186-187;
Ostroff Transcr. at 1371, 1374, 1377-1378.
 -142-

Corp.72 Formby, Transcr. at 1502-03, 1518-19, 1585-86. The

partners of Essex Partnership and their partnership interests

were as follows:

Percentage
Partner partnership interest

MHM 47.500
IRA 26.125
THC 21.375
Connolly 5.000

Eulich attributed Connolly’s relatively modest partnership

interest in Essex Partnership to the fact that Connolly received

a substantial salary from the Gateway Hilton. Eulich, Transcr.

at 1635, 1643-1644.

Essex Corp. and Essex Partnership were both in existence

from January 1982 to December 1984. Formby, Transcr. at 1502-

1503, 1516; Exh. 817. General ledgers were maintained for Essex

Corp. Exh. 697; Formby, Transcr. at 1516. In some instances,

transactions pertaining to Essex Partnership were posted to the

general ledger of Essex Corp., rather than on the partnership’s

books. Formby, Transcr. at 1518.

72
The STJ report, at 56, included the following
recommended finding of fact: “Eulich, Kanter, and Connolly
decided to form the Essex Partnership (Essex), which was
organized in about late 1981”. This recommended finding of fact
is manifestly unreasonable inasmuch as Connolly generally was
unaware of Essex Partnership’s organization and operation.
 -143-

On December 21, 1984, Essex Corp. assigned to Essex

Partnership its rights under the GHM option agreement. Exh. 817,

at 4. The record indicates Essex Corp. also transferred

Connolly’s promissory note to Essex Partnership. Exh. 4013. On

October 26, 1987, Essex Partnership sent a check of $1,000 to

Connolly. Id. The check was accompanied by a letter which

explained that the check represented Essex Partnership’s annual

option payment to Connolly, and the letter included a request

that Connolly remit to Essex Partnership his annual interest

payment of $960. Id.

At trial, Connolly (1) did not know the identity of the

partners of Essex Partnership, (2) believed he was offered a

5-percent partnership interest in Essex Partnership in exchange

for his promise to refer to Eulich any hotel management contracts

that GHM could not handle in the northeastern region of the

country, and (3) did not understand that a portion of GHM’s

management fees was remitted to Essex Partnership. Connolly,

Transcr. at 2631-2645.

Connolly could not recall any details about the GHM option

agreement or whether he had received any payments pursuant to the

option agreement. Connolly, Transcr. at 2661-2662; Exh. 4013.

Connolly did not (1) know whether he had owned all of the shares

of GHM, (2) recall speaking to Eulich about startup financing of
 -144-

$10,000 for GHM, or (3) recall whether the board of directors

held meetings at GHM or the membership of the board. Connolly,

Transcr. at 2650-2653.

h. Essex Partnership Operations

Essex Partnership’s stated purposes were (1) “To engage

generally in the consulting business and as a liaison

intermediary between owners and operators of hotel properties”,

and (2) “To enter into other partnership agreements * * *, to

become a member of a joint venture, or to participate in some

other form of syndication for investment; and to buy, sell,

lease, and deal in services, personal property, and real

property.” Exh. 347. Although the partnership agreement

required its partners to contribute the capital needed to operate

the partnership, very little, if any, actual capital

contributions were ever required from them. There is no evidence

that IRA or THC contributed any capital to Essex Partnership.

Petitioners’ Reply Brief at 457.

Essex Partnership had no office, equipment, or employees

because employees of MHM performed many of the consulting

services that GHM needed. John Formby, an accountant working for

Lexington Investment Co., provided services to MHM and was given

a power of attorney to act on behalf of Essex Partnership.
 -145-

Formby, Transcr. at 1499-1503; Exh. 4007.73 Although the power

of attorney apparently was prepared in December 1982, it was

executed “as of” January 1, 1982. Exh. 4007. Formby performed

accounting services for Essex Partnership, and he performed the

financial and accounting services that GHM required in connection

its hotel management contracts. Formby, Transcr. at 1500-1504,

1590-1591; Exh. 4009.

i. GHM’s and MHM’s Representation and Marketing Agreements

On January 1, 1982, Connolly executed on behalf of GHM an

agreement titled “Representation and Marketing Agreement” with

Essex Partnership (the GHM/Essex agreement) wherein GHM agreed to

pay to Essex Partnership 75 percent of its fees on GHM’s

management contracts on the Gateway Hilton and the Midland Hilton

Hotel.74 In return, Essex Partnership was to (1) “perform

liaison functions between Gateway and certain hotel owners in

connection with management contracts between such parties”, (2)

“perform liaison functions between Gateway and the owners of any

additional properties which it is instrumental in securing for

management by Gateway”, (3) “use its best efforts to maintain

73
Lexington Investment Co. owned a majority of Motor
Hotels Management Co. (MHM). Formby, Transcr. at 1599.
74
This document (Exh. 348) suggests the Midland Hilton
management contract was awarded to Connolly/GHM earlier than
January 1982.
 -146-

satisfactory relations between the property owners and Gateway

under any management contracts * * * and to maintain sufficient

personnel to properly perform such functions”, and (4) use its

best efforts to secure management contracts satisfactory to

Gateway”. Exh. 348.

On January 1, 1982, MHM entered into a nearly identical

“Representation and Marketing Agreement” with Essex Partnership

(the MHM/Essex agreement) in connection with MHM’s management

contracts on the Allentown Hilton and the Madison Hotel. Exh.

349. Although Prudential had helped finance the latter two

hotels’ construction, Prudential apparently had no involvement in

awarding the Allentown Hilton and Madison Hotel management

contracts to MHM, as the two hotels were owned by third parties.

MHM was required to pay to Essex Partnership 30 percent of its

management fees from the operation of the Madison Hotel and 43

percent of the fees from the operation of the Allentown Hilton.

Exh. 349, exh. A.

An MHM employee testified that, in managing GHM, Connolly

was essentially a “one-man show”. A number of MHM’s management

personnel were instructed by MHM’s management to do whatever they

could to help Connolly with GHM’s operations. For instance, MHM

employees helped perform the financial and accounting services

that GHM required in connection with its Gateway and Midland
 -147-

hotel management contracts. In yet another instance, an MHM

employee helped Connolly with union negotiations. Also, after

Prudential awarded the Midland, Texas, hotel’s management

contract to GHM, MHM’s employees helped Connolly find an onsite

manager for that hotel. Although Connolly did give MHM some

occasional help and advice, such as sales presentations to hotel

owners, the volume of services that MHM employees furnished to

GHM greatly exceeded the volume of services that MHM received

from GHM and Connolly.75

In late 1983, Prudential awarded to MHM the hotel management

contract for Prudential’s Hilton-franchised Twin Sixties Hotel at

Dallas, Texas (the Twin Sixties Hotel). Shortly thereafter, MHM

and Essex Partnership entered into a new “Representation and

Marketing Agreement” pursuant to which Essex Partnership received

a percentage of MHM’s fees under the Twin Sixties Hotel

management contract.76 Exh. 350, exh. A. The MHM/Essex

agreement was modified to provide that MHM would pay 70 percent

of its management fees from the Madison Hotel (an increase of 40

75
This paragraph appeared in the STJ report at 58-59 n.22.
76
Robert James, MHM’s president, believed the consulting
and participation agreement for the Twin Sixties Hotel was
entered into to replace the income that Essex Partnership would
lose following the expected termination of MHM’s management
contract for the Allentown Hilton, as the Allentown Hilton was
then in the process of being sold.
 -148-

percent from the 30 percent required under the original

agreement), 57 percent of its management fees from the Allentown

Hilton (an increase of 14 percent from the 43 percent required

under the original agreement), and 57 percent of its management

fees from the newly acquired Twin Sixties Hotel management

contract. Exh. 350, exh. A.

From 1982 through 1986, the specified percentage of fees

Essex Partnership received under the various consulting and fee

participation agreements it had with GHM and MHM varied and, at

times, was adjusted.77 In operating Essex Partnership, the

partners agreed the fees GHM paid Essex Partnership generally

would equal the fees MHM paid to the partnership. The

partnership’s specified percentage of fees under each consulting

and fee participation agreement could easily be adjusted and

modified, as each consulting and fee participation agreement was

subject to cancellation on 30-to-90-days’ notice. As a result,

if a significant change occurred with respect to the compensation

that GHM or MHM received under a particular hotel management

contract, an offsetting change then could be effectuated in the

77
On Jan. 1, 1986, Connolly executed a new Representation
and Marketing Agreement on behalf of GHM which provided that GHM
would pay to Essex Partnership 40 percent of the fees earned on
the Gateway Hilton and Midland Hilton management contracts. Exh.
351. Formby believed this modification was made because
Connolly’s salary was no longer being paid by the Gateway Hilton.
Formby, Transcr. at 1542.
 -149-

other consulting and fee participation agreements GHM and MHM had

with Essex Partnership.

As the total fees that MHM paid to Essex generally equaled

the total fees that GHM (Connolly’s hotel management company)

paid to Essex, the total fees MHM paid to the partnership roughly

approximated MHM’s distributive share of partnership income as a

47.5-percent partner in Essex Partnership. However, as indicated

previously, MHM was not paid directly for the substantial

services its employees rendered to GHM. Rather, as a partner in

Essex Partnership, MHM received 47.5 percent of the partnership’s

income. Although IRA and THC, as partners, also received a

combined 47.5 percent of the income of Essex, IRA and THC, in

contrast to MHM, provided no similar substantial services to GHM.

Eulich and MHM’s top management essentially viewed

involvement in Essex Partnership as a marketing and sales device,

whereby MHM eventually might obtain more management contracts for

large hotels. By having MHM participate in Essex Partnership,

Eulich hoped to have Kanter help MHM obtain additional hotel

management contracts.

Eulich was not familiar with IRA or THC and testified in

pertinent part:

Kanter was the person whose influence and contacts that
we wanted at MHM because of his--again, his involvement
as one of the founders of Hyatt International, his
 -150-

involvement with the Pritzkers, and his involvement,
significant involvement with this Mullett Bay Resort.

I mean, the man--he knew a lot of people in the
hotel business, and he knew people who owned the types
of properties that we wanted, and we were not able to
attract, because we were running the two-story, you
know, freeway-oriented motels. [Eulich, Transcr. at
1633-1634.]

Eulich realized his goal of increasing MHM’s hotel

management business would take some time, as owners of large

hotels did not frequently change hotel management companies with

which they did business. In addition, MHM needed to increase its

level of experience and expertise in managing and operating large

hotels. The arrangement thus described involving Essex and its

partners was apparently satisfactory to all who were involved

with Essex irrespective of the disparate contributions among its

partners.

Connolly could not explain the benefits that GHM would

receive under the GHM/Essex agreement; he did not expect anyone

at Essex Partnership to perform liaison functions between himself

and Prudential. Connolly, Transcr. at 2641-2644. Such a

function or service would be unnecessary because Connolly

believed that he had a “pretty solid relationship with all the

people at Prudential.” Id. at 2643.

Formby did not know what liaison functions Essex Partnership

was expected to perform for GHM, and he believed that no such
 -151-

activities occurred. Formby, Transcr. at 1548-1549, 1555; Exhs.

348, 351.

James, the president of MHM, could not identify a specific

person or entity who would have acted as a liaison between the

owners and operators of the hotel properties in question. James,

Transcr. at 1735-1737. James did not know that IRA and THC were

partners in Essex Partnership until he was shown the partnership

agreement at trial. James, Transcr. at 1734-1737.

There were no officers or employees at Essex Partnership who

could have engaged in consulting or acted as liaisons. Formby,

Transcr. at 1534-1535. Eulich had never seen the Essex

Partnership agreement or the consulting and fee agreements

between MHM or GHM and Essex Partnership. Eulich could not

explain the meaning of the phrase in article II of the Essex

Partnership agreement referring to Essex Partnership’s role as

“liaison intermediary between the owners and operators of hotel

properties”. Eulich, Transcr. at 1631-1634.

j. Transfer of IRA’s Essex Partnership Interest

On December 31, 1984, IRA transferred its 26.125-percent

Essex Partnership interest to Carlco, TMT, and BWK. Carlco and

TMT each received an 11.75-percent partnership interest in Essex,

while BWK received a 2.6125-percent partnership interest in

Essex. Exh. 69, at 16; Exh. 93, at 10; Exh. 114, at 6-7. Essex
 -152-

Partnership apparently was not informed of the transfer and

continued to make partnership distributions to IRA. Petitioners’

Reply Brief at 534.

k. Payments to Essex Partnership and Essex Partnership
Distributions

During 1982 to 1988, Essex Partnership reported that it

received or accrued commission/consulting fee payments from GHM

and MHM as follows:

Year GHM MHM Exhibits

1982 $234,170 $104,121 9074, at 2, acct. Nos.
400100 and 400200
1983 222,557 235,718 707, at 1; Exh. 678,
statement 1
1984 268,663 242,116 726, 353
1985 225,487 230,847 4010, 354, statement 1
1986 68,000 123,089 4011, 355, statement 1
1987 172,963 388,632 837, 356
1988 142,761 238,889 828, 357
Total 1,334,601 1,563,412

For the 1989 taxable year, Essex Partnership reported $293,261 in

total income from consulting fees from MHM and GHM. Exh. 358,

supporting schedule at 1.

For the taxable years 1982 through 1989, Essex Partnership

made distributions to IRA, THC, Connolly, and MHM as set forth in

the following table.
 -153-

Table 8

Year IRA THC Connolly MHM

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 98,753 23,100 219,450
1988 117,562 96,188 22,500 213,750
1989 51,727 42,322 9,900 94,051
Total 788,452 645,099 150,899 1,433,551

Exh. 9074, at 2, acct. Nos. 320000 (1982); Exh. 678, statement 2,

Schedule K-1, item f. (1983); Exh. 353, statement 2, Schedule K-

1, item f. (1984); Exh. 354, statement 2, Schedule K-1, item f.

(1985); Exh. 355, Schedule K-1 (1986); Exh. 356, reconciliation

of partners’ capital accounts (1987); Exh. 357, 1988 diagnostic

Essex Hotel Management Co., at 2, reconciliation of partners'

capital accounts (1988); Exh. 358, Schedule K-1 (1989);

Petitioners’ Reply Brief at 645.

In 1986, MHM was sold by Eulich to an unrelated company

called Aircoa. Aircoa continued to allow MHM to participate as a

partner in Essex Partnership until about 1990.

B. Certain Loans, Payments, and Other Benefits That
Ballard and Lisle and/or Their Family Members
Received (STJ report at 59-64)

Ballard and Lisle established respective grantor trusts (the

CMB and the CMB II Trusts for Ballard and the RWL and the RWL II

Trusts for Lisle). As grantor trusts, the income (or losses) of
 -154-

the trusts was taxable to Ballard and Lisle pursuant to sections

671 through 678. The CMB, CMB II, RWL, and RWL II Trusts each

made investments, as limited partners, in certain movie shelter

partnerships. Kanter or Solomon Weisgal (the trustee of the Bea

Ritch Trusts that owned all of IRA’s common shares) was the

trustee of these trusts. Each Ballard and Lisle trust held no

assets other than its respective movie partnership interest.

Each trust financed the acquisition of its movie partnership

interest through a loan from IRA and International Films, Inc.

(IFI), a corporation in which IRA, at one time, was a majority

shareholder.78 In making loans to the trusts, IRA originally

provided the loan funds and received promissory notes from each

of the trusts; IRA then transferred these trust notes to IFI, in

exchange for IFI’s notes. The trust notes that IFI held, from a

practical standpoint, were collectible only if the movie ventures

78
The parties disagree as to whether these and other loans
to Ballard and Lisle, various trusts of Ballard and Lisle, and to
Mrs. Ballard were bona fide loans, and whether the parties to
these transactions actually intended the funds to be repaid. The
terms “loan”, “promissory note”, and other similar terms are used
herein for convenience and are not intended as ultimate findings
or conclusions concerning whether a bona fide indebtedness
actually existed. Similarly, the parties dispute whether certain
consulting payments that were made to Ballard’s and Lisle’s
children from 1993 through 1989, which are more fully discussed
infra, were in fact, compensation paid for the children’s
consulting work. The use of terms indicating that consulting
payments were made to the children should not be construed as
conveying any legal conclusion as to whether such payments
constituted compensation for services rendered.
 -155-

in which the trusts had invested proved successful, because the

trusts had no other assets available to creditors. IFI had no

recourse against Ballard and Lisle, individually, because the

trusts, not Ballard and Lisle, had borrowed the funds and issued

the promissory notes.79

Ultimately, the movie ventures in which the trusts invested

proved unsuccessful and were not profitable. Additionally, the

Internal Revenue Service later disallowed the deductions that

Ballard claimed on his tax returns with respect to these movie

investments and Ballard was required to pay additional taxes to

the Internal Revenue Service. In July 1985, Mrs. Ballard

borrowed about $160,000 from TMT to pay the income tax liability

that she and Ballard owed.80 Exh. 94, at 10.

In 1987, IFI owed IRA in excess of $500,000 and did not have

sufficient resources to repay IRA. Exh. 34, at 2. To “clean up”

79
Kanter explained that, although, for Federal income tax
purposes, the taxable income or taxable loss of each grantor
trust was required to be reported on Ballard’s or Lisle’s tax
returns, the trusts were otherwise still separate legal entities
for State law purposes. Ballard and Lisle thus were not
personally liable upon the loans of their trusts, as Ballard and
Lisle had not personally guaranteed the loans. Kanter claimed
that he had helped the trusts obtain the loans because the movie
investments originally looked very promising.
80
The STJ report incorrectly stated that Mary Ballard
borrowed the $160,000 from either IFI or IRA. As discussed in
detail in additional findings of fact, infra pp. 178-181, the
Ballards borrowed a total of $303,943 from TMT.
 -156-

IFI’s liability to IRA, Lawrence Freeman (IRA’s president) and

Linda Gallenberger (a TACI employee and an officer of convenience

for IRA) had IFI (of whom IRA was now sole shareholder) transfer

all of its assets to IRA in satisfaction of IFI’s liability to

IRA. Substantially all of the assets IFI transferred consisted

of promissory notes that had been issued by various third

parties, including the above promissory notes of Ballard’s and

Lisle’s grantor trusts, as well as other notes that Ballard and

Lisle had issued individually.81 On its books, IRA reduced IFI’s

1iability to it by an amount equal to the full face amount of the

notes IFI transferred.

As reflected by a memorandum dated July 17, 1987, Lawrence

Freeman (IRA’s president) and Linda Gallenberger agreed that the

loans that IRA was holding that had been made to Ballard and

Lisle, individually, and to their respective grantor trusts would

be “forgiven”, in view of the difficulty of collection.

In 1987, IRA sold for a stated price of $1 each to MAF, Inc.

(MAF), a wholly owned subsidiary of Computer Placement Services,

Inc., the promissory notes of Ballard’s and Lisle’s grantor

trusts that IRA obtained from IFI. MAF had a relatively

insubstantial amount of assets and operated out of the accounting

81
The STJ report lacks detailed findings of fact regarding
loans that IRA and other Kanter-related entities made to Ballard
and Lisle individually. These matters are discussed in detail in
additional findings of fact. See infra pp. 194-205.
 -157-

firm offices of Albert Morrison (MAF’s president). Freeman (who

was then IRA’s president) had asked Morrison (a certified public

accountant and longtime friend of Kanter) to be MAF’s president.

Mr. Morrison received no salary for being MAF’s president. As

MAF’s president, he approved the purchase by MAF of the

promissory notes from the trusts as a favor to Kanter.82

IRA subsequently also sold 100 percent of IFI’s outstanding

shares of stock to Linda Gallenberger for $1 in September 1988.

Shortly thereafter, Ms. Gallenberger placed IFI into bankruptcy.

On its 1987 tax return, IRA claimed losses with respect to

its sale of the trust notes to MAF. IRA also claimed bad debt

deductions with respect to the individual notes of Ballard and

Lisle that it obtained from IFI. It further claimed a $65,000

worthless security deduction with respect to the IFI shares that

were later sold to Ms. Gallenberger.

For substantially all of the period from about 1983 to 1989,

KWJ Corp. (an IRA subsidiary) and later the KWJ Partnership

(whose partners were IRA’s subsidiaries BWK, Carlco, and TMT)

paid monthly “consulting fees” of $1,000 each to Ballard’s two

daughters and to Lisle’s son and daughter. After the Internal

Revenue Service commenced examinations of many of Ballard’s,

82
IRA’s purported sale of promissory notes to MAF, Inc.,
is discussed in detail in additional findings of fact. See infra
pp. 196-205.
 -158-

Kanter’s, and Lisle’s respective returns for the years at issue,

Kanter, in February 1990, sent letters to the children

terminating KWJ Partnership’s “consulting arrangement” with

them.83 In two of these termination letters, Kanter apprised the

children that he had recently assumed IRA’s presidency. He noted

that their consulting arrangement had begun when Lawrence Freeman

was IRA’s president. In the letters, Kanter stated that the

children had done nothing for a number of years, and he blamed

Mr. Freeman for having KWJ Partnership continue to make monthly

payments to them.84

After becoming IRA’s acting president in 1989, Kanter also

discussed with Ballard and with Lisle the payment of their

individual promissory notes that IRA held but had previously

deducted as bad debts on IRA’s 1987 return. Since at least 1987,

Ballard had claimed that neither he nor his wife were liable on

the promissory notes that they had previously executed. In late

1992, Ballard agreed to pay IRA $120,000 in settlement of his

$196,000 debt to IRA on his promissory notes. Ballard also

entered into an arrangement, at about this time, to repay the

$160,000 loan his wife had received from TMT in July 1985.

83
Melinda Ballard’s consulting arrangement had been
terminated earlier in late 1988.
84
Pertinent portions of the text of these letters are
quoted infra pp. 193-194.
 -159-

Kanter reached a similar agreement with Lisle to discharge

his debt to IRA. Originally, pursuant to certain payment

negotiations Kanter and Lisle had in 1989, Lisle agreed to pay

the debt in 2 years. He failed to do so, and he and Kanter

discussed the matter again, until Lisle, at some point, agreed to

pay the debt by the end of 1993. However, Lisle died before

making any payment, and Kanter, acting on behalf of IRA, filed a

claim against Lisle’s estate.

Beginning in about 1990, Ballard was paid a salary by TMT,

and Lisle was paid a salary by Carlco. Kanter, who was now IRA’s

president, agreed to have each of these IRA subsidiaries pay a

salary to Ballard and Lisle. Ballard had requested that TMT pay

him a salary. At various times from 1987 through 1989, some of

Ballard’s family trusts had also received loans from TMT in order

to make certain real estate investments.

IV. Additional Findings of Fact: The Flow of Funds

Other than the limited discussion concerning loans to

Ballard and Lisle and their family trusts set forth above, the

STJ report did not include an analysis of the flow of funds that

respondent offered as further proof that the payments from The

Five constituted income earned by and properly taxable to Kanter,

Ballard, and Lisle. The following additional findings of fact

focus on the payments from The Five to IRA, THC, and other

Kanter-related entities and how those funds were transferred to
 -160-

Kanter, Ballard, and Lisle, including a number of purported loans

to Kanter, Ballard, Lisle, and their trusts. Because some of the

payments from The Five to IRA were accumulated in IRA until 1983

and then transferred to Carlco, TMT, and BWK, we shall analyze

separately the transfers of funds for the periods before 1984 and

after 1983.

The Court’s additional findings of fact are divided into

eight sections. Section A provides both an overview of the

payments made by The Five to IRA and its subsidiaries in

connection with the various Prudential transactions from 1977 to

1989, and a breakdown of those payments for the periods 1977 to

1983 and 1984 to 1989. Sections B, C, and D focus on the

distribution of those funds to Kanter, Ballard, Lisle, and their

family members and trusts for the periods 1977 to 1983 and 1984

to 1989. Section E discusses payments made by The Five to THC

and its subsidiaries during the years at issue. Sections F and G

discuss the distribution of those funds to Kanter and Lisle.

Where necessary to add context, we restate some of the

findings of fact set forth and properly supported by citations of

the record earlier in this report. We do not repeat the

citations of the record for these findings of fact.

A. Payments Made by The Five to IRA and Its Subsidiaries
From 1977 to 1989

The following is a summary of the payments The Five made to

IRA and its subsidiaries in connection with the various
 -161-

transactions discussed above during the entire period 1977

through 1989.

Table 9

Schnitzer/ Eulich/
Year Hyatt1 Frey Schaffel PMS Essex Total

1977 $54,848 -- -- –- -- $54,848
1978 60,739 -- -- –- -- 60,739
1979 -- -- $100,000 $150,000 -- 250,000
1980 119,719 $127,372 244,920 533,425 -- 1,025,436
1981 90,070 105,764 361,525 534,696 -- 1,092,055
1982 172,702 538,781 447,450 361,692 $86,212 1,606,837
2
1983 172,090 110,125 244,731 361,692 78,376 967,014
1984 186,094 103,500 -- 361,692 133,238 784,524
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 1,773,889 1,114,305 1,398,626 4,590,388 788,455 9,665,663
1
Except for the amounts listed for 1977 and 1978 (which were paid to KWJ
Corp. before IRA purchased all of KWJ Corp.’s common stock), the amounts that
IRA received from the Hyatt Corp. payments are net of the 30-percent share
paid to Weaver.
2
The $244,731 amount listed as a Schaffel payment for 1983 includes the
$213,750 that he paid to IRA following the first deal with Travelers.

See Tables 2, 3, 5, 7, and 8, supra, and accompanying citations

of the record.

During the period 1983 to 1989, IRA maintained cash deposits

as set forth in the following table:
 -162-

Table 10

Year Amount

1983 $140,675
1984 54,201
1985 13,140
1986 326,783
1
1987 1,251,723
1988 1,332,565
2
1989 613,298
1
In 1987, IRA sold stock (identified as Hyatt Air) and
received proceeds of $1,115,560. Exh. 22 (Form 6252); Exh. 9000,
at 4. IRA invested these proceeds in certificates of deposit
between 1987 and 1989. Exh. 34, at 1-2; Exh. 35.
2
In 1989, IRA’s cash on hand was reduced in substantial
part by a loan of $600,000 that IRA made to Kanter. Exh. 36, at
6; Exh. 9114, at 15.

Exhs. 18-24, Schedules L.

The remainder of this section is divided into two

subsections. Subsection 1 addresses all of the payments made by

The Five during 1977 through 1983. These payments were paid to

and accumulated by IRA and reported on IRA’s consolidated

returns. Subsection 2 addresses all of the payments made by The

Five during 1984 through 1989. These payments were paid to IRA

and/or other Kanter-related entities and distributed to Carlco,

TMT, and BWK, at a time when the latter entities were no longer

part of IRA’s consolidated group for tax reporting purposes.

1. Payments Made During 1977 Through 1983

As Table 9 reflects, during the period 1977 through 1983,

IRA received (1) $670,168 from Hyatt Corp. (70 percent of Hyatt
 -163-

Corp.’s payments to KWJ Corp.),85 $882,042 from Frey (through

payments to IRA’s subsidiary, Zeus), (3) $1,398,626 from

Schaffel, (4) $1,941,505 from Schnitzer/PMS (through installment

85
During 1977 through 1983, Hyatt Corp. paid a total of
$907,845 to KWJ Corp. pursuant to the Hyatt/KWJ agreement. See
Table 2, supra p. 90. In early 1979, IRA acquired from Weaver
all of KWJ Corp.’s common stock for $150,000. At the time, KWJ
Corp. had net assets of $115,084. The record also leaves open
the possibility that Hyatt Corp. made a payment to KWJ Corp. for
1978 (a payment that would have been made in early 1979). See
supra p. 90 (Handelsman). After 1978, Weaver forwarded the Hyatt
Corp. payments to Kanter, who had TACI negotiate the checks and
then distribute to Weaver his 30-percent share of each payment.
Petitioners’ Reply Brief at 537. IRA deducted the payments to
Weaver as a commission expense. With the exception of interest
income of $13,796, the payments from Hyatt Corp. represented KWJ
Corp.’s sole source of funds. Exh. 9076 (Kuck Summary # 2.b.);
Exh. 10, at 15; Exh. 14, at 6; Exh. 17, at 15; Exh. 18, at 19;
Kuck, Transcr. at 3445-3446.

KWJ Corp.’s total application of funds for 1979 through 1983
was approximately $674,900 as follows:

Year Application Amount Exhibit

1979 Dividend to IRA $60,000 10, at 4, sched. M-2,
Kuck, Transcr. at
3446
1980 -- -- --
1981/82 Dividend to IRA 260,000 14, at 40, l. 5
17, at 27; l. 28
25, at 21; Kuck,
Transcr. at 3446-
3447
1983 Dividend to IRA 297,900 18, at 30
1982 Consulting Fees 21,000 17, at 16, l. 23
1983 Consulting Fees 36,000 18, at 20
Total 674,900
 -164-

payments of principal and interest), and (5) $164,588 from

Eulich/Essex Partnership, for a total of $5,056,929.

Before 1984, all payments that IRA and its subsidiaries

received from The Five in connection with the Prudential

transactions described above were reported on IRA’s consolidated

returns. No tax was paid on this income because, during 1978

through 1983, IRA reported substantial net operating losses. See

Table 1, supra p. 48.

2. Payments Made During 1984 to 1989

After 1983, Kanter altered the structure for the receipt of

payments from The Five. Although Hyatt continued to issue checks

payable to KWJ Corp., IRA (which purchased KWJ Corp. in 1979)

liquidated the company in December 1983. At the same time,

Carlco, TMT, and BWK formed the KWJ Partnership, which began

receiving the Hyatt payments. Thereafter, the Hyatt payments

were no longer reported on IRA’s consolidated returns but were

reported on the respective returns of Carlco, TMT, and BWK in

accordance with their distributive shares (45/45/10 percent,

respectively) of KWJ Partnership items. Exhs. 61-66 (Carlco);

Exhs. 84-89 (TMT); Exhs. 106-111 (BWK).

In 1984, in connection with Lisle’s move to Travelers,

Schaffel made a final payment of $213,750 to IRA and then began

making payments to THC.
 -165-

Frey continued to make payments to IRA’s subsidiary Zeus

during 1984 and 1985.

Schnitzer/PMS continued to make principal and interest

payments to IRA with the exception of its final (accelerated)

payment, which was remitted to PSAC and then distributed to

Carlco, TMT, and BWK.

In December 1984, IRA transferred its interest in Essex

Partnership to Carlco (45 percent), TMT (45 percent), and BWK (10

percent). See discussion infra pp. 170-171. Therefore, IRA no

longer reported income from Essex Partnership on its consolidated

returns. Although Essex Partnership continued to make payments

to IRA, those payments were transferred to Carlco, TMT, and BWK,

which reported the payments in accordance with their distributive

shares of Essex Partnership items. Exhs. 61-66 (Carlco); Exhs.

84-89 (TMT); Exhs. 106-111 (BWK).

As Table 9 reflects, during the period 1984 to 1989, IRA

received (1) $1,103,721 from Hyatt Corp. (through payments to KWJ

Corp.),86 $232,263 from Frey (through payments to Zeus), (3)

$2,648,883 from Schnitzer/PMS (through installment payments of

86
During 1984 through 1989, Hyatt Corp. continued to issue
checks to Weaver made payable to KWJ Corp., and Weaver continued
to forward those checks to Kanter. After Kanter’s office
returned 30 percent of the payments to Weaver, KWJ Partnership
received the balance or $1,103,721.
 -166-

principal and interest), and (4) $623,867 from Eulich/Essex

Partnership, for a total of $4,608,734.87

After 1983, IRA reported as income only the payments from

Frey to IRA’s subsidiary Zeus and the payments from PMS. Exhs.

19-24 (Schedule 6252); Exh. 19, at 12; Exh. 20, at 16.

B. Distribution of the Funds Paid by The Five in Connection
With the Various Prudential Transactions to Kanter,
Ballard, Lisle, and Their Respective Family Members

This section is divided into three subsections. The first

subsection provides background regarding Carlco, TMT, and BWK.

The second subsection discusses the transfer of funds from IRA to

Carlco, TMT, and BWK. The third subsection discusses the

disposition of funds from Carlco, TMT, and BWK for the benefit of

Ballard, Lisle, Kanter, and their respective families.

1. Additional Details Regarding Management and Control of
Carlco, TMT, and BWK

a. Carlco

Lisle and members of his family were officers of Carlco with

signatory authority on its various accounts. Exh. 2030, at 35.88

There is no dispute that Lisle managed and controlled Carlco’s

investments. During 1984 through 1989, moneys from Carlco were

deposited in a brokerage account maintained at Goldman Sachs.

87
All payments from Schaffel during this period were
remitted to THC, as discussed infra pp. 207-208.
88
For a list of Carlco’s officers and directors for the
period in question, see app. 2 to this report.
 -167-

Exh. 527. The mailing address of this account was Lisle’s home

address. Id.

b. TMT

Freeman, Gallenberger, and Meyers were listed as TMT’s

officers and directors during the period 1983 to 1989.89 There

is no dispute Ballard managed and controlled TMT’s investments.

TMT listed the following bank and brokerage accounts as

assets on its general ledgers for 1983 through 1989: A Wells

Fargo account, a Citizen Bank account, a Goldman Sachs brokerage

account, and a Kemper money market account. Exh. 9014; Exhs. 92-

98.

During 1984 through 1989, moneys from TMT were deposited in

an account maintained at the Wells Fargo Bank in San Francisco.

The mailing address of this account was Ballard’s home address.

Mary Ballard, Transcr. at 2817. Ballard opened this account in

the name of TMT, and he and his wife had signatory authority over

it. Ballard, Transcr. at 223-224; Exhs. 614-617. The records

for TMT were maintained at Ballard’s home.

c. BWK

The officers and directors of BWK included Kanter, Meyers,

Gallenberger, and Weisgal.90 Kanter testified that he did not

89
For a list of TMT’s officers and directors for the
period in question, see app. 3 to this report.
90
For a list of BWK’s officers and directors for the period
in question, see app. 4 of this report.
 -168-

have the time to manage BWK’s assets as he had originally

planned. Kanter, Transcr. at 3695.

2. IRA’s Transfers to Carlco, TMT, and BWK of Funds Paid
by The Five

a. Funds Paid by The Five to IRA During 1977 Through
1983 Transferred to Carlco, TMT, and BWK

During 1977 through 1983, payments made by The Five to IRA

in connection with the various Prudential transactions discussed

above totaled approximately $5 million.

Beginning in 1984, Kanter purportedly directed that IRA’s

“free-cashflow” be distributed in the ratio of 45 percent each to

Carlco and TMT and 10 percent to BWK. From 1984 through 1989,

IRA generally transferred funds and other assets to Carlco, TMT,

and BWK, in the respective 45/45/10 percent allocation ratio

Kanter had directed.

During 1984, approximately $4.2 million was transferred from

IRA to Carlco, TMT, and BWK in a 45/45/10 percent split by way of

(1) transfers through the TACI Special E and the TACI Special

Accounts and (2) distributions related to Essex Partnership and a

partnership known as Sherwood Associates Partnership. Exhs.

2003, 2006, 2010.
 -169-

(i). Transfers From Zeus to IRA

The payments that Zeus received from BJF from 1980 through

1983, a total of $882,042, accumulated in Zeus until they were

transferred to IRA in the steps outlined below.

(1) At a time unknown, but before March 25, 1983, IRA lent

Zeus $51,000. Exh. 26, at 24, last item.

(2) On March 25, 1983, Zeus transferred $51,000 to IRA as a

loan repayment. Exh. 26, at 24, last item.

(3) At a time unknown, but before October 21, 1983, IRA

transferred $774,000 or a cash equivalent to THC in exchange for

a receivable of $774,000 due from THC. Exh. 27, at 5 (AJE-25);

Exh. 26, at 11 (11-22-83); Petitioners’ Reply Brief at 491-492.

(4) On October 21, 1983, Zeus transferred $774,000 to IRA

in exchange for the $774,000 THC receivable. Exh. 27, at 5 (AJE-

25); Exh. 26, at 11 (11-22-83).

(5) At a time unknown, but before December 5, 1983, IRA

transferred $13,000 or a cash equivalent to THC in exchange for a

receivable of $13,000 due from THC. Exh. 26, at 23.

(6) On December 5, 1983, Zeus transferred $13,000 to IRA in

exchange for a $13,000 THC receivable. Exh. 26, at 23; Kuck,

Transcr. at 3428-3443. Thus, at the end of 1983, Zeus retained

$44,042 of the $882,042 paid by BJF, and Zeus held THC notes

receivable totaling $787,000.
 -170-

On January 12, 1984, Zeus transferred $5,028 to IRA in

exchange for a $5,028 THC receivable. Exh. 9070, at 2.

By the end of 1989, the THC receivables that Zeus received

from IRA had not been repaid. Exh. 9070, at 2, 7 (1984 and 1989

general ledgers). There is no evidence in the record that Zeus

ever accrued any interest or received any principal payment in

connection with the THC receivables identified above.

(ii). IRA’s Transfer of Its Interest in Essex Partnership

As previously mentioned, in December 1984 IRA distributed to

Carlco, TMT, and BWK its 26.125-percent partnership interest in

Essex Partnership. The details of that transaction are

summarized as follows.

In January of 1984, IRA recorded the receipt of a $44,413

payment received from Essex Partnership as payables of $19,986

due to each of Carlco and TMT and $4,441 due to BWK. Exh. 29, at

6. On January 30, 1984, IRA issued a check in the appropriate

amount to each of the corporations and recorded the payments as

payment of the payables owed to Carlco, TMT, and BWK. Exh. 29,

at 1. Additional distributions from Essex Partnership to IRA

during 1984 totaling $88,825 were also treated as distributed

directly to Carlco, TMT, and BWK, by reducing the additions to

capital attributable to IRA’s contributions of cash made to the

corporations during the year. Exh. 29, at 17.
 -171-

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
5/8/84 (26,125)
7/6/84 (26,125)
10/4/84 (36,575)
Plus “distb exxex dist as pd in” 88,825

Investment end of year -0-

Exh. 29, at 17.

Lisle professed to have no knowledge that Carlco held an

interest in Essex Partnership. Exh. 2030, at 39.

(iii). IRA’s Transfer of Its Interest in Sherwood
Partnership

In December 1984, IRA also transferred to Carlco, TMT, and

BWK its 50-percent partnership interest in Sherwood Associates

Partnership (Sherwood), as more fully described below.

In 1982, IRA invested $175,000 in Sherwood and reported a

partnership loss of $89,577 for that year. Exh. 26, at 14.

In 1983, IRA invested an additional $150,000 in Sherwood and

reported a partnership loss of $287,165 for that year. Exh. 26,

at 30.

In 1984, IRA transferred its 50-percent partnership interest

in Sherwood to TMT (22.5 percent), Carlco (22.5 percent), and BWK

(5 percent). Exh. 9014 (AJE 7 for 12/31/84); Exh. 69, at 16;
 -172-

Exh. 93, at 10; Exh. 114, at 6-7; Petitioners’ Reply Brief at

524-525. When IRA distributed its Sherwood Partnership interest

to Carlco, TMT, and BWK in 1984, IRA reported a gain of $51,744

on the distribution (apparently representing the difference

between IRA’s capital contributions of $325,000 and partnership

losses totaling $376,742 that IRA reported for 1982 and 1983).

Exh. 19, at 5 of 25.

In 1985, IRA reported a long-term capital loss of $46,925

attributable to the sale of a note receivable from Sherwood.

Exh. 20, at 5. IRA reported that it acquired the note receivable

in October 1984 and sold the note for $1,000 on December 1, 1985.

Id. Neither IRA’s general ledger nor its trial balance ledger

for 1984 reflects the acquisition of a Sherwood promissory note.

(iv). Accounting Treatment

Carlco, TMT, and BWK recorded IRA’s cash distributions as

capital contributions, and they recorded IRA’s transfers of its

Essex and Sherwood partnership interests as paid-in capital, as

follows:
 -173-

Item Carlco TMT BWK

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 1,851,090 1,956,292 411,469
Paid-in capital
Beginning year 7,398 7,398 7,398
Yearend 1984 1,858,488 1,963,690 418,867

Exh. 69, at 16; Exh. 93, at 10, Exh. 114, at 6-7; Exh. 29, at

18-20.

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

transferred capital contributions and paid-in capital to Carlco,

TMT, and BWK as follows:

Carlco TMT BWK

$1,856,942 $1,962,144 $417,321

Exhs. 31, 29.

(v). Additional Capital Contributions to Sherwood
Partnership

Between 1984 and 1987, TMT, Carlco, and BWK made capital

contributions to Sherwood, and their distributive shares of

Sherwood’s Partnership items (income/losses) were as follows:
 -174-

TMT Carlco BWK

Capital Income/Loss Capital Income/Loss Capital Income/Loss

1
1984 $41,400 ($119,117) $41,400 ($119,117) $9,200 ($26,470)
1985 36,000 (100,147) 36,000 (100,147) 8,000 (22,255)
1986 –- ( 74,101) -– 74,102) -- (16,468)
1987 11,137 (121,462) 11,135 (120,817) 2,475 (26,998)
Total 88,537 (414,827) 88,535 (414,183) 19,675 (92,191)

1
The record includes a letter from Meyers to Lisle, dated Oct. 16,
1984, informing him that TACI applied $40,690 representing Carlco’s share of
an installment payment that IRA received from PMS to partially offset $41,400
that Carlco owed to Sherwood Partnership. Exh. 2073.

Exh. 93, at 4; Exh. 94, at 5; Exh. 96, at 4 (TMT); Exh. 69, at

2, 7; Exh. 70, at 4; Exh. 72, at 4 (Carlco); Exh. 114, at 5; Exh.

115, at 4; Exh. 117, at 2 (BWK).

In 1986, Sherwood changed its name to Forest Activity.

Exhs. 9013-9015.

b. Transfer of Funds Paid by The Five During 1984 Through
1989 to Carlco, TMT, and BWK

During 1984 through 1989, the moneys paid by The Five to

IRA, other Kanter-related entities, and/or Carlco, TMT, and BWK

totaled approximately $4.6 million.

(i). Hyatt Corp.

As previously discussed, payments under the Hyatt/KWJ

agreement (after Weaver’s 30-percent share) were distributed to

Carlco, TMT, and BWK in a 45/45/10 percent split through KWJ

Partnership.
 -175-

KWJ Partnership’s total source of funds during the

years 1984 through 1989 was $1,359,691, which included capital

contributions of $6,100, Hyatt Corp. payments of $1,103,721, and

IRA loans of $249,870. Petitioners’ Reply Brief at 538.

IRA made loans to KWJ Partnership totaling $30,000, $45,000,

$38,000, $48,000, $20,000, and $68,000 during 1984 to 1989,

respectively. See app. 5 to this report. As of July 30, 1990

(the date KWJ Partnership filed its tax return for 1989), these

loans had not been repaid. Exh. 957. These loans provided a

large portion of the funds KWJ Partnership used to make

consulting payments to Ballard’s and Lisle’s children as

discussed in additional findings of fact infra pp. 192-194.

During 1984 to 1989, Carlco’s, TMT’s, and BWK’s distributive

shares of the Hyatt Corp. payments to KWJ Corp. were $496,539,

$496,539, and $110,342, respectively. Exhs. 61-66, 84-89, 106-

111; Petitioners’ Reply Brief at 538.

One additional matter regarding the Hyatt Corp. payments

deserves mention. On August 2, 1989, IRA issued checks of

$22,619 each to Ballard and Lisle. After the checks were issued

to Ballard and Lisle, IRA records reflected a transfer of $45,237

to KWJ Partnership on August 8, 1989. Also on August 8 and 15,

1989, IRA ledger entries reflected that the checks issued to

Lisle and Ballard, respectively, were void. Exh. 36, at 9.
 -176-

Despite the fact that IRA’s ledger entries showed that these

checks were void, Lisle’s 1989 return reflected that he actually

cashed the check. Lisle reported the $22,619 on his individual

tax return as income from the “KJW [sic] Company.” Exh. 421,

Statement 1.

(ii). Frey

The $232,263 that BJF paid to Zeus during 1984 and 1985 was

not transferred directly to IRA. In 1986, Zeus apparently used

these funds to purchase preferred stock in Windy City Corp. Exh.

9070. Nevertheless, the amounts paid to Zeus roughly equaled the

otherwise unaccounted-for loans in the aggregate amount of

$250,000 that IRA made to KWJ Partnership during the period 1984

to 1989. See app. 5 to this report.

(iii). Schnitzer/PMS

During the period 1984 to 1989, the $2,287,191 in

installment payments that IRA received from PMS was transferred

to Carlco, TMT, and BWK in a 45/45/10 percent split and treated

as capital contributions.91

(iv). Essex Partnership

From 1984 through 1989, Essex Partnership paid a total of

$623,865 to IRA. See Table 8 and accompanying citations of the

91
For a schedule listing the transfers of PMS installment
payments from IRA to Carlco, TMT, and BWK, see app. 6 to this
report.
 -177-

record. IRA distributed these payments as payables to Carlco,

TMT, and BWK in a 45/45/10 percent split, and they in turn

reported their respective shares of these distributions on their

tax returns. Exhs. 61-66 (Carlco); Exhs. 84-89 (TMT); Exhs. 106-

111 (BWK). Essex Partnership income was allocated to Carlco,

TMT, and BWK during 1984 through 1989, as follows:

Year Carlco TMT BWK

1984 $59,957 $59,957 $13,324
1985 54,079 54,079 12,018
1986 36,210 36,210 8,047
1987 54,314 54,314 12,070
1988 52,903 52,903 11,756
1989 23,277 23,277 5,173
Total 280,740 280,740 62,388

Exhs. 29, 32-36.

c. Carlco, TMT, and BWK Capital Accounts

At the end of 1989, IRA’s records reflected that it made

capital contributions and transferred paid-in capital to Carlco,

TMT, and BWK as follows:

Carlco TMT BWK

$2,938,173 $3,320,267 $652,250

Exh. 74, at 12-13 (Carlco); Exh. 98, at 9 (TMT); Exh. 119, at 2

(BWK). The $382,094 difference between Carlco’s and TMT’s

capital accounts at the end of 1989 was attributable to TMT’s

accounting for so-called consent dividends during the period 1984
 -178-

to 1988.92 Notably, TMT reversed the consent dividends in 1989.

Exh. 98, at 9. As a result, Carlco’s and TMT’s capital accounts

at the end of 1989 both equaled $2,938,173.

3. The Disposition of Funds From Carlco, TMT, and BWK for
the Benefit of Ballard, Lisle, Kanter, and Their
Families

a. Ballard’s Use and Enjoyment of TMT’s Assets

(i). TMT’s Various Accounts

During the period 1984 to 1989, substantial portions of

TMT’s funds were invested in CDs (American National Bank

(Chicago) and Wells Fargo Bank (San Francisco)), savings and

money market accounts (Citizen Bank, Wells Fargo, TACI, and

Kemper Money Market), and a Goldman Sachs brokerage account.

Exhs. 92-98; Exh. 93, at 7; Exh. 94, at 5-9; Exh. 614, at 2; Exh.

95, at 2, 6; Exh. 9014; Exhs. 614-617. Ballard and his wife had

signatory authority over the Wells Fargo savings account.

Ballard, Transcr. at 223-224.

(ii). Loans From TMT to Ballard and Ballard Entities

Seabright Corp. was owned by the Mary Family Trust. Mary

Ballard, Transcr. at 2813-2815, 2823. The beneficiaries of the

Mary Family Trust were Mary Ballard and her three daughters. Id.

92
TMT recorded consent dividends of $105,202, $97,206,
$82,633, $31,960, and $65,093 (a total of $382,094) for 1984 to
1988, respectively. Exh. 93, at 11; Exh. 94, at 11; Exh. 98, at
9.
 -179-

Kanter served as trustee. Id. Seabright Corp. owned Seabright

Farm located outside Little Rock, Arkansas. Id. at 2822.93

TACI’s June 30, 1984, trial balance ledger reflected that

loans had been made to Ballard, Seabright Trust,94 and Seabright

Corp. as follows:

Ballard Seabright Trust Seabright Corp.

$10,000 $11,300 $29,840

Exh. 175, at 3-4; Exh. 174, at 93, 95, 97-98.

On August 7, 1984, money was transferred from the TACI

Special E Account to the TACI Special Account designated for

Ballard, Seabright Trust, and Seabright Corp. in the following

amounts:

Ballard Seabright Trust Seabright Corp.

$10,599 $12,253 $31,435

Exhs. 5426, 5425, 5416. This transfer of funds had the effect of

eliminating the outstanding loans from TACI’s books and records

in that the loans were treated as having been paid. Exh. 179, at

29 (ref. Nos. DPO80, DPO79, DPO81). In connection with this

transaction, as IRA was transferring funds to Carlco, TMT, and

93
The records of Seabright Corp. were maintained at
Ballard’s residence. Mary Ballard, Transcr. at 2817. Mary
Ballard was an officer of Seabright Corp. Id.
94
Ballard believed Seabright Trust invested in tax-
sheltered investments. Ballard, Transcr. at 248.
 -180-

BWK as capital contributions, book entries were made reflecting

that the three loans described above were transferred to TMT.

Exh. 93, at 8-9.

From 1984 through 1989, Seabright Trust and Seabright Corp.

received additional loans from TMT. The balances on these loans

at the end of each year were as follows:

Seabright Seabright
Year Trust Corp. Exhibit

1984 $53,055 $31,440 93, at 8-9
1985 79,155 31,520 94, at 9-10
1986 100,155 36,520 95, at 40
1987 100,155 41,520 96, at 2
1988 135,155 41,520 97, at 2
1989 135,155 41,520 98, at 4

The record does not include any promissory notes issued in

connection with the loans to Seabright Trust or Seabright Corp.

There is no evidence that either Seabright Trust or Seabright

Corp. paid interest or principal on the loans from TMT. As of

December, 31, 1989, the loans had not been repaid. Exh. 98, at

4.

From 1984 through 1989, TMT made loans totaling $303,943 to

Claude Ballard and Mary Ballard. The balances due on these loans

at the end of each year were as follows:
 -181-

Year Claude Ballard Mary Ballard Exhibit

1984 $10,599 -- 93, at 4
1985 10,599 $160,000 94, at 10
1986 16,599 160,000 95, at 4
1987 36,943 160,000 96, at 2-3
1988 136,943 160,000 97, at 2
1989 146,943 160,000 98, at 4

An agreement dated December 26, 1986, purported to provide

for the repayment of the $160,000 loan to Mary Ballard with

Macy’s preferred convertible stock that Ballard owned. Exh.

9098. However, TMT’s accounting records do not indicate that the

$160,000 loan was ever repaid or that the Macy’s stock was

transferred to TMT in accordance with the December 26, 1986,

agreement. Exh. 98, at 4.95

(iii). TMT’s Property Transferred to Ballard

In 1986, TMT paid $100,000 to acquire property described in

TMT’s general ledger as “LAND ST. FRANCIS COUNTY [ARKANSAS]

414.28 ACRE”. Exh. 95, at 4. An adjusting journal entry for

1986 regarding this transaction stated “to record purchase of 2/7

on 414.28 acres in St. Francis County, Arkansas.” Id. An

adjusting journal entry for 1987 regarding this transaction

stated “to r/c amounts loaned to Claude for purchase of Fairfield

Planting Co. (See agreement in file).” Exh. 9014, at 34. The

414.29 acres of Arkansas land were no longer listed as a TMT

95
As discussed supra p. 158, Kanter and Ballard negotiated
the repayment of this debt in late 1992.
 -182-

asset. Exh. 96, at 4. Fairfield Planting Co. (Fairfield) was an

S corporation involved in farm operations in Arkansas. Exh. 95,

at 4; Ballard, Transcr. at 236.

On January 20, 1987, Ballard executed a promissory note

which provided that (1) Ballard agreed to pay to TMT, on demand,

the principal sum of $100,000, and (2) the note would not bear

interest, but TMT was entitled to receive 90 percent of the

“dividends” paid to Ballard by Fairfield. Exh. 9018. At the

same time, Ballard and Mary Ballard, acting as TMT’s president,

executed an agreement which stated that (1) Ballard was executing

a promissory note to TMT and was pledging 1,000 shares of

Fairfield common stock as security for the note, and (2) TMT, as

part of the transaction, agreed to advance in the future “any

deficits incurred by * * * Ballard in the operations of Fairfield

* * * and is to receive 90% of the dividends paid by Fairfield”.

Id. Ballard and Mary Ballard (acting in her individual capacity)

also executed an assignment which stated that “for the purpose of

securing the payment of all indebtedness now owing, or which may

at any time hereafter be owing” by Ballard to TMT, the Ballards

assigned to TMT 1,000 shares of Fairfield common stock. Id.

In 1987, TMT apparently paid an additional $20,344 to

Fairfield, and this amount was treated as an additional loan to

Ballard. Exh. 96, at 2.
 -183-

The Ballards reported Fairfield items of income and loss on

their 1987, 1988, and 1989 tax returns. Exhs. 391-393.

When Gallenberger was questioned about the accounting

entries for the Fairfield transaction, she could not recall the

details and suggested Ballard should be questioned on the

matter.96 Ballard believed that (1) he owed TMT approximately

$200,000 on the Fairfield transaction, (2) TMT continued to

receive “interest” on the deal, (3) he owned two-sevenths of

Fairfield, (4) the initial Fairfield investment was $1,350,000

and the investment had increased in value to approximately

$2,350,000, and (5) the Fairfield transaction was a good deal for

TMT and a bad deal for Ballard. Ballard, Transcr. at 249-250,

286-288. There is no evidence in the record that TMT ever

received any payments (interest, dividends, or otherwise)

attributable to Ballard’s promissory note described above.

The record is unclear as to whether TMT ever owned shares in

Fairfield that it could transfer to Ballard. Ballard asserted in

Petitioners’ Reply Brief at 625-626 that because Fairfield was an

96
Petitioners argued in their Reply Brief at 626 that
respondent failed to establish any relevant facts regarding the
accounting surrounding the Fairfield transaction because
respondent failed to question Gallenberger about the matter. To
the contrary, respondent’s counsel questioned Gallenberger about
the details of the transaction, and her reply ultimately was “ask
Claude”. Gallenberger, Transcr. at 2477-2481.
 -184-

S corporation, TMT could not own stock in the company. LaRue,

Transcr. at 3587. Nevertheless, TMT’s adjusting journal entries

identified the property that was transferred to Ballard as

“Fairfield Planting Company” (Exh. 9014, at 34), while TMT’s

general ledger identified the asset that was transferred to

Ballard as land (not shares of stock). Exh. 96, at 4.97

Gallenberger could not explain the Fairfield transaction at

all, and Ballard’s testimony regarding the matter was

inconsistent with TMT’s general ledger entries. Ballard’s

explanation suggests that (1) Ballard received a TMT asset worth

considerably more than the amount recorded on TMT’s books, and

(2) Ballard issued a promissory note to TMT that he never

intended to repay.

(iv). Investment in Melinda Ballard’s Company

Ficom International, Inc. (Ficom), was a corporation

organized by Ballard’s daughter, Melinda Ballard, in 1983.

Melinda Ballard, Transcr. at 3721, 3724. In 1986, TMT

transferred $4,000 to Ficom as a loan. Exhs. 9014, 614. In

1988, TMT recorded in its trial balance ledger a $15,000

97
TMT’s general ledger reflected an additional transaction
involving what appears to be separate property in St. Francis
County, Ark., identified as land valued at $424,800, along with a
building ($25,200), and building improvements ($10,925). Exh.
95, at 4.
 -185-

investment in Ficom stock. Exh. 9014, at 6. The entry included

a handwritten notation “W/O in 1989.” Id.; Exh. 97, at 5. In

1989, TMT recorded in its trial balance ledger a $15,000 long-

term capital loss on its investment in Ficom, with an adjusting

journal entry explaining the writeoff as follows: “To w/o

worthless stock of Ficom as per note on 1988 TB [trial balance]”.

Exh. 9014, at 21 (AJE 6). TMT claimed a long-term capital loss

of $15,000 related to the Ficom transaction on its tax return for

1989. Exh. 89, Sch. D. As of December 31, 1989, $1,000 of TMT’s

loan to Ficom had not been repaid. Exh. 98.

(v). Ballard’s Disclosures to Goldman Sachs

Goldman Sachs had a conflict of interest policy regarding

partners’ and employees’ outside business affiliations, which

required a written request for consent to establish an outside

business affiliation. Exh. 5938, at 3-4. Goldman Sachs also had

a private securities transaction policy requiring all partners

and employees to notify Goldman Sachs when they personally became

involved in any private securities transactions, including an

investment in a private tax shelter. Id. at 4.

During the period 1987 to 1989, Ballard reported as income

on his tax returns substantial director’s fees from Seabright

Corp. Exhs. 391-393. On October 14, 1988, Ballard submitted a

disclosure statement to Goldman Sachs which stated: “I am
 -186-

personally involved in substantial farming operations

individually as well as in partnership form. Family trusts

control two corporations which are similarly involved.” Exh.

9072. At trial, Ballard testified that the family trusts

referred to in his disclosure statement to Goldman Sachs were the

Bea Ritch Trusts, which purportedly owned IRA (and ostensibly

TMT), and the two corporations he was referring to were TMT and

Fairfield. Ballard, Transcr. at 235-236.

Ballard’s testimony on this point is inconsistent with his

earlier testimony and is not credible. In particular, Ballard

testified that, as of 1987, he owned Fairfield–-there is no

evidence that a trust owned Fairfield. The family trusts and two

corporations mentioned in Ballard’s disclosure statement were the

Orient Trust (which owned TMT) and Mary Family Trust (which owned

Seabright Corp.).

On June 13, 1989, Goldman Sachs issued a memorandum

regarding “Outside Business Activities and Private Investment”

reminding Goldman Sachs personnel of NYSE and NASD rules that

required each general partner and employee to obtain prior

written approval with respect to outside business activities and

private investments. Exh. 5938, at 11. In response to this

reminder, on August 2, 1989, Ballard submitted to the Goldman

Sachs compliance department a Request for Approval of Outside
 -187-

Business Activities and/or Private Investments Form. Exh. 1029.

In response to a direction to provide a “Complete description of

the investment or business affiliation. What is it and who else

is involved in it as principals? Does it involve a public or

private company?”, Ballard answered, in part: “Farmland--Have

been buying and selling for years.” Id. Ballard did not

identify IRA or TMT as principals and/or private companies with

regard to these activities.

When Ballard became the director of an organization called

ICM Property Investors, Ballard submitted to Goldman Sachs an

“Outside Business Activities Information and Request Form”. Exh.

1031. Ballard’s involvement with this organization was through a

“close friend” who controlled the property. Id. In contrast,

Ballard never submitted such a form to Goldman Sachs with respect

to TMT, which he purportedly was managing for IRA at Kanter’s

request.

(vi). TMT’s Assets

During 1984, 1985, and 1986, TMT had total assets of

$2,015,911, $2,289,151, and $2,520,852, respectively. Exhs. 93,

94, 95. TMT’s cash holdings during 1984, 1985, and 1986 totaled

$1,899,873, 1,906,516, and $50,803, respectively. Id. By 1986,

TMT had transferred approximately $1.2 million to a Goldman Sachs
 -188-

brokerage account and invested approximately $900,000 in real

estate investments. Id.

During 1987, 1988, and 1989, TMT had total assets of

$2,773,138, $3,240,582, and $4,855,921, respectively. Exhs.

9014, 96-98. TMT’s cash holdings during 1987, 1988, and 1989

totaled $232,635, $243,386 and $492,817, respectively. Id.

TMT’s notes receivable during 1987, 1988, and 1989 totaled

$433,618, $472,618, and $482,618, respectively. Id. During

1987, 1988, and 1989, TMT’s investments in bonds (including

municipal bonds) totaled $1,102,948, $1,288,862, and $1,477,690,

respectively. Id.

b. Lisle’s Use and Enjoyment of Carlco’s Assets

(i). Carlco’s Various Accounts

During 1984 through 1989, Carlco’s funds were deposited in

TACI accounts, a brokerage account (Goldman Sachs), and in bank

accounts (Connecticut National Bank and North Dallas Bank).

Exhs. 527, 610, 611, 612. The mailing addresses for Carlco’s

accounts were Lisle’s home address, and Lisle and Donna Lisle

(his wife) had signatory authority over these accounts. Id.98

98
The Lisles and Henry Lisle (Lisle’s brother) had
signatory authority on the Goldman Sachs brokerage account. Exh.
527.
 -189-

(ii). Lisle’s Personal Use of Carlco’s Funds

During 1983 to 1991, RWL Cinema Trust I99 made annual

payments of $2,948.50 to New Jersey Life Insurance Co. Exh.

1121, at 4. RWL Cinema Trust I made these payments out of annual

loans of $3,000 from a variety of Kanter-related entities (IFI,

TACI, IRA, and BWK). Id. In 1985, TACI made one (and only one)

loan of $3,000 to RWL Cinema Trust I. Id.

On April 12, 1985, Lisle wrote a check of $3,000 against

funds in Carlco’s account at Connecticut National Bank to repay a

loan from TACI. Exh. 612 (April bank statement, check No. 1011,

Bates 000318). The memo section of this check stated: “Payment

on Loan”. Id. Lisle used Carlco’s funds to repay the loan TACI

made to RWL Cinema Trust I. This payment did not generate a loan

from Carlco to RWL Cinema Trust, or a loan from IRA to the RWL

Cinema Trust, or a loan from Carlco to Lisle, Exh. 70; Exh. 32.

No loan arose from this transaction because the money in the

Connecticut National Bank account belonged to Lisle, and he used

that money to pay a personal debt.

(iii). Carlco’s Assets

During 1984 through 1989, Carlco’s assets totaled

$1,967,188, $2,327,066, $2,699,998, $3,078,545, $3,728,530, and

99
The RWL Cinema Trust I, a Lisle grantor trust, is
discussed in greater detail infra pp. 195-205, with regard to
loans from other Kanter-related entities.
 -190-

$4,404,569, respectively. Exhs. 9015, 61-66. During 1984

through 1989, Carlco’s assets were invested almost entirely in

municipal bonds. Id.

c. Kanter’s Use and Enjoyment of BWK’s Assets

(i). Salaries and Officer Compensation Paid to Kanter
and His Son

During 1984 through 1989, Kanter and his son, Joshua Kanter,

received salaries from BWK in the following amounts:

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

Exhs. 115-119 (BWK ledgers); Exhs. 106-111 (BWK returns). Kanter

testified, however, that he did not have time to manage BWK.

Kanter, Transcr. at 3695.

(ii). Loans

On April 11, 1985, BWK lent $400,000 to Kanter. Exh. 115,

at 3. By the end of 1987, the $400,000 loan had not been repaid.

Exh. 117. In 1988 and 1989, the $400,000 loan was reduced by

approximately $30,000 each year by adjusting journal entries

which treated the reduction of the loan as salary to Kanter.

Exh. 9013, at 1, 11 (AJE 2); Exh. 5504. BWK’s ledgers and
 -191-

returns reflect interest income from CDs only, and there is no

indication that Kanter paid any interest on the $400,000 loan.

Exhs. 107-111, 115-119.

During the period 1987 to 1989, BWK lent a total of $236,000

to PSAC to support its operations. Gallenberger, Transcr. at

1985-1986; Petitioners’ Reply Brief at 636. There is no evidence

that any principal or interest was paid to BWK on these loans.

Id.

(iii). Gifts

BWK’s general ledger for 1986 included an August 4, 1984,

entry for $1,000 which stated: “JANIS (Kanter) GIFT.” Exh.

2006. A subsequent entry in BWK’s general ledger suggests Kanter

reimbursed BWK for the above-referenced gift in March 1987. Id.

There is no suggestion in the ledger that Kanter paid BWK any

interest related to this transaction.

C. Other Means Used To Transfer Funds for the Benefit of
Ballard, Lisle, Kanter, and Their Respective Families

1. Payments From IRA, KWJ Corp., and KWJ Partnership

a. IRA Payments to Ballard and Lisle in 1982

In 1982, Ballard received $12,500 from IRA as a director’s

fee. Exh. 473. Ballard asserted he was not an IRA director and

the payment was for consulting services. Ballard, Transcr. at

218.
 -192-

On March 2, 1982, IRA paid Lisle $1,157.84. Exh. 606 (Bates

No. 0003209).

b. Consulting Fees Paid by KWJ Corp. and KWJ Partnership
to Ballard’s and Lisle’s Adult Children

Melinda Ballard and Karen Ballard Hart were Ballard’s

daughters. Melinda Ballard, Transcr. at 3720; Hart, Transcr. at

2776. Amy Albrecht was Lisle’s daughter, and Thomas Lisle was

Lisle’s son. Albrecht, Transcr. at 914; Thomas Lisle, Transcr.

at 927.

In 1982, KWJ Corp. began paying Thomas Lisle, Amy Albrecht,

and Melinda Ballard $1,000 each per month by checks drawn on the

TACI Special E Account. Exh. 17, at 16, l. 23; Kanter, Transcr.

at 3644-3645; Exh. 9100. These payments continued during 1983.

Exh. 18, at 20; Exh. 935; Melinda Ballard, Transcr. at 3723;

Thomas Lisle, Transcr. at 930-931.

Beginning in 1984, after KWJ Corp. was liquidated, Thomas

Lisle, Amy Albrecht, and Melinda Ballard continued to receive

$1,000 each per month from the newly formed KWJ Partnership.

Exh. 176 (multiple pages 2-20). In November 1984, Karen Ballard

Hart also began receiving $1,000 per month from KWJ Partnership.

Id. at 18. These payments generally continued until 1989. Exhs.

476, 9009.
 -193-

The payments to the Ballard and Lisle children from KWJ

Corp. and KWJ Partnership totaled $323,000, as summarized below:

Year KWJ Partnership KWJ Corp.

1982 -- $21,000
1983 -- 36,000
1984 $38,000 --
1
1985 47,000 --
1986 49,000 --
1987 48,000 --
1988 48,000 --
2
1989 36,000 --
Total 266,000 57,000
1
Melinda Ballard received a total of $11,000 in 1985 and
$13,000 in 1986. Melinda Ballard, Transcr. at 3743-3744.
2
Of the $36,000 paid in 1989, Lisle’s children received at
least $18,000, and Ballard’s children received at least $12,000.
Exhs. 431, 957.

Exh. 17, at 16, l. 23 (1982); Exh. 18, at 20 (1983); Exh. 176, at

2, 5, 6, 8, 11, 12, 13, 15, 16, 18, 20; Exh. 475, at 1, 3, 5, 6,

8, 10, 12, 14, 16, 18, 20; Exh. 479; Albrecht, Transcr. at 919

(1984 to 1989).

In early February 1990, after the Internal Revenue Service

began examining Ballard’s, Kanter’s, and Lisle’s tax returns for

the years at issue, Kanter sent letters to Ballard’s and Lisle’s

children terminating their “consulting arrangement”. Exhs. 476,

9009. In his letter to Amy Albrecht, Kanter stated that

“fundamentally no services appear to have been performed for a
 -194-

number of years”. Exh. 476. Kanter explained why Albrecht

continued to receive the monthly payments as follows:

Regrettably, from * * * [IRA’s] point of view (clearly
not yours), Mr. Freeman was preoccupied during that
time with other personal difficulties that were
protracted and distractive of his attention in
virtually every respect. I do not believe you are
aware of any of those difficulties and there is no need
to dwell on the point, other than to tell you that
during that time, he paid no attention to the
activities of * * * [IRA] and its affiliates, and those
who were simply administering tasks on behalf of * * *
[IRA] routinely continued to make payments to you since
they had no contrary instructions.

Exh. 476, at 2; Albrecht, Transcr. at 921. The record includes a

nearly identical letter that Kanter wrote to Thomas Lisle. Exh.

9099; Thomas Lisle, Transcr. at 937.

2. Additional Loans

a. IRA Loans to Kanter

IRA lent various amounts to Kanter during the period 1982 to

1989. Exhs. 25, 26, 29, 32-36. By the end of 1989, Kanter owed

$600,000 to IRA. Exh. 36, at 6. There is no evidence of notes

for these loans, and there is no evidence that any principal or

interest was paid on these loans.

b. Loans to Ballard, Lisle, Their Family Members,
and Their Trusts

(i). Ballard’s Grantor Trusts

Ballard was the settlor of the following grantor trusts,

with the trustees and beneficiaries, as indicated:
 -195-

Type of Trust
Trust name trust established Trustee Beneficiary Exhibit
1
CMB Cinema Grantor 10/23/73 Kanter/ Ballard’s 5102
Weisgal wife and
children
CMB Cinema II Grantor 7/15/75 Kanter Ballard’s 5020
wife and
children
Summit Grantor 6/3/80 Weisgal Ballard’s 5105
wife and
children
Seabright Grantor 11/2/81 Kanter Ballard’s 5001
children

1
In 1979, the CMB Cinema Trust was divided into 10 separate trusts.
Exh. 5102.

On May 29, 1976, CMB Cinema Venture Partnership was formed.

Exh. 5104. The partners were the CMB Cinema Trust (10 percent)

and the CMB Cinema Trust II (90 percent) with respect to the

Division B participation. Id. sch. A.

(ii). Lisle’s Grantor Trusts

Lisle was the settlor of the following grantor trusts with

the trustees and beneficiaries as indicated:

Type of Trust
Trust Name Trust Established Trustee Beneficiary Exhibit

RWL Cinema Grantor 10/23/73 Kanter Lisle’s 5019
descendants
RWL Cinema II Grantor 7/15/75 Kanter Lisle’s 5000
wife and
children
Basking Ridge Grantor 6/3/80 Weisgal Lisle’s 5103
wife and
children

Ballard’s CMB Cinema Trust was formed on the same day as

Lisle’s RWL Cinema Trust (October 23, 1973), Ballard’s CMB Cinema

Trust II was formed on the same day as Lisle’s RWL Cinema Trust

II (July 15, 1975), and Ballard’s Summit Trust was formed on the
 -196-

same day as Lisle’s Basking Ridge Trust (June 3, 1980). We shall

refer to these various entities collectively as Lisle’s grantor

trusts and Ballard’s grantor trusts.

(iii). International Films, Inc.

International Films, Inc. (IFI), was incorporated in

September 1973. Exh. 955. As of August 31, 1986, IRA owned 71

percent of IFI’s voting stock. Id. IRA’s general ledger

reflected that its basis in its IFI stock was $65,000. Exh. 34,

at 7. At the end of 1987, CMB Cinema Venture also was an IFI

shareholder. Exh. 5932.

IRA lent substantial sums to IFI, and, as of January 1987,

IFI owed $507,708 to IRA. Exh. 34, at 2. As discussed below,

Ballard’s and Lisle’s grantor trusts borrowed substantial sums

from IFI to invest in IFI tax shelters.

(iv). Harbor Exchange Lending Operation

Harbor Investments, Inc., was incorporated on July 21, 1978,

and its stated business purpose was investments. Exh. 153, at

19. The firm’s name was changed in fiscal year ending August 31,

1980, to Harbor Exchange Lending Operation (HELO). Exh. 156, at

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

voting stock of HELO, and THC owned 100 percent of Active’s

stock. Exh. 156, at 12, 21. THC filed a consolidated return

with both Active and HELO for the fiscal years ending August 31,
 -197-

1978, 1979, 1980, and 1984. Exh. 153, at 18, 19, 25; Exh. 154,

at 24, 27; Exh. 156, at 22; Exh. 157, at 6.

Before 1983, IRA transferred $1,189,900 to HELO purportedly

as loans. Exh. 26, at 23.

(v). Loans to Lisle and His Trusts

During the 1970s and 1980s Kanter-related entities,

including IRA, IFI, TACI, BWK, and HELO, made loans of more than

$200,000 to Lisle and Lisle’s grantor trusts. Exh. 1120; Exh.

1121, at 2-4; Exh. 5016, Exh. 5932; Exh. 9006, at 2.

(vi). Loans to the Ballards and Their Trusts

During the 1970s and 1980s, Kanter-related entities,

including IRA, IFI, TACI, HELO, and TMT, made loans of more than

$550,000 to Ballard, his family members, and Ballard’s grantor

trusts. Exh. 1119; Exh. 1122; Exh. 5911; Exh. 5932; Exh. 9189;

Exh. 9005, at 2, l. 18 (AJE 9); Exh. 174, at 93, 95; Exh. 175, at

3-4.

IRA transferred receivables of $160,400 and $500 due from

Ballard, individually, to IFI in exchange for receivables due

from IFI in like amounts. Exh. 9005, at 4, ll. 24-26 (AJE 21);

Exh. 26, at 28.

(vii). Writeoff of Loans and Claimed Losses

Before the end of 1983, HELO lent $95,000 to Lisle’s Basking

Ridge Trust and $106,200 to Ballard’s Summit Trust. Exh. 9006,
 -198-

at 2 (AJE 9); Exh. 1104. By the end of 1983, a transaction took

place between IRA and HELO which had the effect of (1) decreasing

IRA’s outstanding receivables due from HELO by $201,200, (Exh.

9006, at 2 (AJE 9); Exh. 26, at 23), and (2) increasing IRA loans

to Basking Ridge Trust and Summit Trusts by $201,200. Exh. 9006,

at 2 (AJE 9); Exh. 26, at 26. In short, IRA obtained HELO’s

receivables due from Basking Ridge Trust and Summit Trust. IRA’s

adjusting journal entry stated that the purpose of this

transaction was “to adjust for loans made to Basking Ridge and

Summit via HELO (remove HELO from middle).” Exh. 9006, at 2, l.

16. Simultaneously with this book entry transaction, Basking

Ridge Trust was credited with a payment of $10,300, leaving

$84,700 due on its loan, and Summit Trust was credited with a

payment of $10,100, leaving $96,100 due on its loan. Exh. 26, at

26. IRA then transferred to IFI the receivables due from Basking

Ridge Trust and Summit Trust for a receivable of $180,800 due

from IFI. Exh. 9006, at 5 (AJE 27).

Loans to Ballard, Lisle, and their grantor trusts were

either sold for $1 or written off as bad debts as described in

the following steps.
 -199-

Step 1

As of December 17, 1987, IFI held receivables due from

Ballard, Lisle, and their grantor trusts totaling $582,646, as

follows:

IFI Receivables

Ballard $35,748
Ballard 160,900
CMB Cinema 70,650
CMB II 16,675
Summit 96,100
CMB Cinema
Ventures 250
Subtotal $380,323
Lisle $28,284
RWL Cinema 21,500
RWL II 67,839
Basking Ridge 84,700
Subtotal 202,323
Total 582,646

Exh. 9019, at 3; Exh. 5932; Petitioners’ Reply Brief at 572.

Additionally, as of December 17, 1987, IFI held receivables due

from the entities and individuals totaling $538,013, as follows:

IFI Receivables

Safari Trust $98,450
HGA Cinema 133,695
Elk Invest. 76,500
Interalia 125,000
Hargen 8,000
THC 29,500
Abernathy 67,098
Total 538,243

Petitioners’ Reply Brief at 572.
 -200-

Step 2

As previously mentioned, IRA held a receivable of $507,648

due from IFI. Exh. 34, at 2. On December 17, 1987, IRA

exchanged its $507,648 receivable due from IFI for all of IFI’s

remaining assets, which included a partnership interest in 1984

Development Partnership (assigned a value of $55,288), and IFI’s

receivables listed below:

IFI Receivables

Ballard $35,748
Ballard 160,900
CMB Cinema Trust 70,650
CMB Cinema Trust II 16,675
HELO (re: Summit) 96,100
CMB Cinema Ventures 250
Lisle 28,284
RWL Cinema 21,500
RWL Cinema II 67,839
HELO (re: Basking
Ridge) 84,700
Safari Trust 98,450
HGA Cinema 133,695
Elk Invest. 76,500
Interalia 125,000
Hargen 8,000
THC 29,500
Abernathy 67,098
Total 1,120,889

Petitioners’ Reply Brief at 573-576; Exh. 9019

Step 3

MAF, Inc. (MAF), was a subsidiary of a Kanter-related entity

known as Computer Placement Services, Inc. Gallenberger,

Transcr. at 2025-2027. Albert Morrison, Jr., a C.P.A., served as
 -201-

MAF’s president as a favor to Freeman. Morrison, Transcr. at

4505, 4513, 4519. Morrison was a longtime friend of Kanter.

Morrison, Transcr. at 4518.

Simultaneously with the transfer of IFI’s receivables to IRA

(listed above), IRA sold 10 of the receivables (with a face value

of approximately $800,000) to MAF, Inc., for $1 per receivable or

a total of $10. Exh. 5911, at 6 (AJE 9, ll. 17-29); Exh. 5911,

at 9 (AJE 23, ll. 26-28); Exh. 34. The 10 receivables in

question were those of Safari Trust, CMB Cinema Trust, CMB Cinema

Trust II, RWL Cinema Trust, RWL Cinema Trust II, HGA Cinema

Trust, Elk Investment Partnership, Inter Alia, Hargen, and HELO

(the Basking Ridge Trust and Summit Trust notes). Exh. 5911, at

6 (AJE 9); Petitioners’ Reply Brief at 574.

Step 4

With regard to Ballard’s promissory notes (totaling

$196,648) and Lisle’s promissory note ($28,284), IRA’s adjusting

journal entries for 1987 reveal that IRA (1) substantially

discounted the value of these notes, as well as a small

receivable due from CMB Cinema Ventures (Exh. 5911, at 7 (AJE

12)), and (2) wrote off the balances, $84,889 due from Ballard

and $12,185 due from Lisle, as bad debts. Exh. 5911, at 10 (AJE

28, lines 15-19). IRA’s adjusting journal entry stated that this

transaction was undertaken “to write-off worthless notes.” Exh.
 -202-

34, at 5 (acct. Nos. 1210 and 1211); Exh. 5911, at 10 (AJE 28,

lines 15-19). IRA claimed a bad debt loss with respect to

Ballard’s and Lisle’s notes on its tax return for 1987. Exh. 22.

By the end of 1987, IRA still held a receivable of $485,825

due from HELO and a receivable of $345,869 due from Cedilla

Investment Co. Exh. 9189. On December 22, 1987, IRA sold to MAF

for $1 the HELO and Cedilla Investment Co. receivables totaling

$831,692. Exh. 34, at 13, first entry; Exh. 5911 (AJE 32, last

page).

On December 22, 1987, IRA also sold its interest in 1984

Development Partnership to MAF for a promissory note for $1,000.

Exh. 9189. IRA claimed a long-term capital loss of $22,862

attributable to this transaction on its 1987 tax return. Exh.

22, Schedule D.

Morrison (through MAF) entered into the transactions with

IRA described above merely as an accommodation to Kanter.

Morrison, Transcr. at 4530. After purchasing the notes from IRA,

MAF did no other business. Morrison, Transcr. at 4517.

By the end of 1987, neither Ballard nor Lisle owed any

portion of their original loans totaling $196,648 and $28,284,

respectively, to either IRA or IFI. CMB Cinema Ventures no

longer owed $250 to either IRA or IFI. Likewise, Ballard’s and
 -203-

Lisle’s grantor trusts’ original loans totaling approximately

$357,000 were no longer owed to IRA or IFI. Exh. 34.

In 1987, Ballard reported $2,400,252 of total income on his

Federal income tax return, including $212,309 of interest and

dividend income and $1,018,367 of capital gain income. Exh. 391.

In 1987, Ballard had the resources to repay either IRA or IFI the

loans he had received individually and through his trusts.

Although IRA wrote off Ballard’s receivable as a bad debt,

Ballard did not report the discharge of this indebtedness as

income on his 1987 tax return or on subsequent returns. Exhs.

391-393.

In 1987, Lisle reported $746,923 of total income on his

Federal income tax return, including $255,707 of interest and

dividend income. Exh. 418. In 1987, Lisle had the resources to

repay either IRA or IFI the loans he had received individually

and through his trusts. Although IRA wrote off Lisle’s

receivable as a bad debt, Lisle did not report the discharge of

this indebtedness as income on his 1987 tax return or on

subsequent returns. Exhs. 418-421.

Neither Ballard, Lisle, nor their grantor trusts paid any

interest to IFI or IRA on the loans to them which were

subsequently written off as bad debts or sold for $1. Exhs. 383-

393, Exhs. 417-421; Exhs. 954, 955 (IFI returns). The record
 -204-

does not include loan documents or notes evidencing the loans to

Ballard, Lisle, and their grantor trusts.

At the end of 1987, IRA sold its IFI stock to Gallenberger

for $1. Exh. 5912, at 7 (AJE 6). In addition to receiving the

IFI stock, Gallenberger was given $3,000 identified as accounting

fees. Exh. 9020; Exh. 35, at 12. IRA claimed a long-term

capital loss of $65,000 attributable to this transaction on its

1987 tax return. Exh. 22, Schedule D.

In March 1989, approximately 2 years after IFI transferred

receivables of $1,120,889 to IRA, IFI filed for bankruptcy. Exh.

627. At the time of the bankruptcy filing, Gallenberger was

IFI’s vice president, and she owned 100 percent of its stock. At

the time of IFI’s bankruptcy, IFI owed debts to the following

creditors:

Creditor Reason Amount of Claims

IRS 1984 taxes $5,500
Kanter Legal services 750
Neal, Gerber
& Eisenberg Legal services 550
PSAC Services 700
I&F Corp. Services 775
Total 8,275

Exh. 627.
 -205-

(viii). Loans to Lisle’s RWL Cinema Trust During
1988 to 1990

In 1988, the year after IRA wrote off Lisle’s loans and the

loans to RWL Cinema, RWL Cinema II, and Basking Ridge Trust, as

described above, IRA made another loan of $6,000 to the RWL

Cinema Trust. Exh. 1121, at 4; Exh. 35, at 4. In addition,

Kanter lent a total of $6,000 to Lisle’s RWL Cinema Trust during

1989 and 1990. Exh. 1121, at 4.

D. Summary of Funds Paid by The Five to IRA and Disposition
of Those Funds for the Benefit of Kanter, Ballard,
Lisle, and Their Families

The following table is a summary of the funds paid by The

Five to IRA during 1977 through 1989 and the disposition of those

funds for the benefit of Ballard, Lisle, Kanter, and their

respective families.
 -206-

Table 11
Total funds IRA received from The Five 1977-89 $9,665,663
IRA Distributions to Carlco/TMT/BWK 1984-89
IRA capital contributions 1984-89 (6,528,596)
IRA noncapital contributions 1984 (44,411)
KWJ distributions (973,158)
Essex distributions (623,865)
(8,170,030) (8,170,030)
Total 1,495,633

Distributions to Ballard and Lisle,
their family members and their
family/grantor trusts (as opposed to
transfers to Carlco, TMT and BWK)
(Spread sheet below) (904,304)
1
591,329

CMB CMB CMB
Ballard’s Cinema Cinema Summit Cinema Ballard's
Source Ballard Trust Trust II Trust Ventures Family Total

IRA $35,748 $70,650 $16,675 $96,100 $250 --
Loans 160,900 –- –- –- –- –-
KWJ
(1983) –- –- –- –- –- $12,000
(1984-89) –- –- –- –- –- 128,000
IRA
Direc-
tor’s
fee 12,500 –- –- –- –- –-
Total 209,148 70,650 16,675 96,100 250 140,000 532,823

Lisle’s RWL Cinema RWL Cinema Basking Ridge Lisle's
Source Lisle Trust Trust II Trust Family
IRA
Loans $28,284 $67,839 $21,500 $84,700 --
-- 6,000 -- -- --
IRA
Payment 1,158 –- –- –- –-
KWJ
(1983) -- -- -- -- $24,000
(1984-89) -- -- -- -- 138,000
Total 29,442 73,839 21,500 84,700 162,000 371,481
904,304

1
The $591,329 difference can be accounted for by way of the amounts IRA (and
Zeus) invested in (1) Frey’s partnerships (at least $100,000), Sherwood Partnership
($325,000), PMS ($150,000), and the $18,000 IRA transferred to Carlco, TMT, and BWK
in 1983 in exchange for common stock. These amounts (totaling $593,000) were
unavailable for distribution to Carlco, TMT, and BWK.
 -207-

E. Payments Made by The Five to THC and Its Subsidiaries
During 1981 Through 1989

Schaffel, Frey, and Essex Partnership made payments to THC

and its subsidiaries during 1981 through 1989 totaling $3,909,369

as set forth in the following table:

Table 12

Year Schaffel Frey Essex Total

1981 -- $80,616 -- $80,616
1982 -- -- $70,538 70,538
1983 -- 16,200 64,125 80,325
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 98,753 132,323
1988 -- -- 96,188 96,188
1989 -- –- 42,322 42,322
Total 2,763,500 500,770 645,099 3,909,369

See Tables 4, 6, 8; Petitioners’ Reply Brief at 645-646.

During 1984 to 1986, Schaffel made payments to THC totaling

$2,763,500 representing Kanter’s share of fees that Schaffel

earned arranging Travelers financing for Walters’s projects.

During 1981 through 1987, Frey made payments to THC totaling

$500,770. These payments included shares of development and

management fees pursuant to Kanter’s and Frey’s oral agreement,

as well as shares of profits from Prudential projects and

development fees from projects not involving Prudential

properties pursuant to the Frey/THC agreement. These payments

served to compensate Kanter for using his influence to obtain

Prudential projects for Frey and for using his influence to bring
 -208-

wealthy investors to Frey’s projects not involving Prudential

properties.

During 1982 through 1989, Essex Partnership made payments to

THC totaling $645,009 representing cash distributions on THC’s

partnership interest. These payments served to compensate Kanter

for obtaining hotel management contracts for MHM.

F. Distribution of Funds From THC to Kanter

The payments THC received from Schaffel, Frey, and Essex

Partnership during the years at issue generally were deposited

into THC’s bank account. Petitioners’ Reply Brief at 646.

During 1983, THC transferred $2,335,298 from its account to

TACI’s accounts. Exhs. 148, 149, 174; Petitioners’ Reply Brief

at 646.100 These transfers were identified in THC’s general

ledgers as investments, loans, or repayments of loans.

Petitioners’ Reply Brief at 647. During 1983, $1,339,843 was

transferred from TACI’s accounts back to THC identified as

returns on THC’s investments, loans from TACI, and repayments of

earlier loans from THC to TACI. Exh. 5406, Petitioners’ Reply

100
See app. 7 to this report.
 -209-

Brief at 647-648.101 At the end of 1983, THC had $392,539 in

TACI’s accounts. Petitioners’ Reply Brief at 648-649.

During 1984, THC transferred $1,194,000 from its bank

account to TACI’s accounts. Exhs. 149, 150; Petitioners’ Reply

Brief at 649.102 These transfers were identified in THC’s general

ledgers as investments, loans, or repayments of loans.

Petitioners’ Reply Brief at 649-650. During 1984, $756,300 was

transferred from TACI’s accounts to THC’s account, and in most

instances these transfers were identified as returns on THC’s

investments. Exh. 5406; Petitioners’ Reply Brief at 650-651.103

By the end of 1984, the net increase in THC’s funds deposited

with TACI was $434,700, for a total of approximately $827,000.

Petitioners’ Reply Brief at 651-652.

During 1983 and 1984, a total of $1,525,458 was transferred

from the TACI Special Account to Kanter’s personal bank account

identified as loans and retainer fees, as follows:

101
See app. 8 to this report. Only portions of THC’s
general ledgers were provided to respondent. Nevertheless, at
the end of 1983, THC had approximately $400,000 remaining in TACI
accounts. Petitioners’ Reply Brief at 648-649; Exh. 174.
102
See app. 9 to this report.
103
See app. 10 to this report.
 -210-

Transfer Amount Appendix

1983 (loans) $407,458 11
1984 (loans) 909,000 12
1983 (retainer fees) 24,000 13
1984 (retainer fees) 24,000 14
1984 (loans) 161,000 15
Total 1,525,458

Exh. 9078; Petitioners’ Reply Brief at 654-655.

Kanter’s personal bank account records for the period

December 1982 through December 1984 show that Kanter made

withdrawals for his personal benefit and the benefit of his

family. Exh. 5408 (items 1-730); Petitioners’ Reply Brief at

652-653.

As of October 31, 1987, Kanter had outstanding loans from

TACI totaling $1,346,641. Exh. 9113; Petitioners’ Reply Brief at

656-657.

As discussed, supra pp. 64-65, TACI filed for bankruptcy in

February 1988. Lawrence Korrub, TACI’s bankruptcy attorney,

never received the records that TACI maintained for Kanter and

his related entities because Gallenberger sent TACI’s books and

records, including the bank statements and canceled checks

related to the TACI Special E and TACI Special Accounts, to

Kanter. Gallenberger, Transcr. at 1970-1973. There is no

evidence of notes for any of the funds transferred from the TACI

accounts to Kanter’s personal bank account, nor is there any
 -211-

evidence that Kanter repaid the approximately $1.3 million that

he owed TACI at the time of its bankruptcy. Considering all of

the circumstances, we infer that Kanter directed the transfer of

THC’S funds into TACI’s accounts as well as the subsequent

transfers from TACI’s accounts into his personal bank account.

Kanter did not intend to return these funds to either TACI or THC

because these funds belonged to Kanter.

G. The Flow of Funds From Four Ponds and One River Through
FPC Subventure to Kanter and Lisle

As previously discussed, Kanter acquired an 8-percent

limited partnership interest in Four Ponds Partnership and

transferred that partnership interest to FPC Subventure

Partnership. Lisle acquired a 90-percent interest in FPC

Subventure Partnership in exchange for a $2,880 promissory note.

Kanter then acquired an 8-percent limited partnership interest in

One River Partnership and transferred that interest to FPC

Subventure Partnership in exchange for a $2,000 promissory note.

As a result of his interest in FPC Subventure Partnership, Lisle

indirectly held partnership interests in Four Ponds Partnership

and One River Partnership. FPC Subventure Partnership’s primary

sources of income were Four Ponds Partnership and One River

Partnership. Exhs. 914-917.
 -212-

Four Ponds Partnership and One River Partnership (1)

reported net losses for 1981 to 1984 and 1987 to 1989 totaling

$1,067,131, and (2) made cash distributions to its partners in

1981 to 1984 and 1987 to 1989 totaling $731,080. Respondent’s

Opening Brief at 349-350, par. 1016; Petitioners’ Reply Brief at

663-664; Exhs. 125-134 (Kanter); Exhs. 417-421 (Lisle); Exhs.

9090-9094 (FPC Subventure Partnership tax returns and Schedules

K-1 for Four Ponds Partnership and One River Partnership).104

Approximately 7 percent of Four Ponds Partnership’s and One River

Partnership’s losses, described above, flowed through to Lisle

from FPC Subventure Partnership. Exhs. 417-421.

The cash distributions made to FPC Subventure Partnership

from Four Ponds and One River were deposited into the TACI

Special E Account. Exh. 205; Exh. 176, at 10, 15; Exh. 174, at

126-127. Shortly after the money from Four Ponds and One River

was deposited into the TACI Special E Account, 90 percent of that

money was distributed directly to Lisle. Exh. 176, at 10, 15;

Exhs. 914-917; Exh. 5415. During the period 1981 to 1989, Lisle

received a total of $682,520 in cash distributions from FPC

Subventure Partnership. Exhs. 9090-9094, 417-421. A Schedule K-

1 that FPC Subventure Partnership issued to Lisle for 1989 showed

104
FPC Subventure Partnership’s tax returns for 1985 and
1986 apparently were not made part of the record.
 -213-

that his capital account at the end of 1989 was negative

$2,745,636. Exh. 9092.

A Schedule K-1 that Four Ponds issued to Kanter for 1989

showed that Kanter/FPC Subventure Partnership’s capital account

at the end of 1989 was a negative $1,288,755. Exh. 215. A

Schedule K-1 that One River Partnership issued to Kanter for 1989

showed that Kanter/FPC Subventure Partnership’s capital account

at the end of 1989 was negative $1,767,981. Exh. 9094.

FPC Subventure Partnership was a conduit that Kanter used to

transfer to Lisle a share of the payments that Schaffel made to

THC on Travelers transactions from 1984 to 1986.

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

As previously discussed, the Kanters paid a small amount of

Federal income tax for 1978. The Kanters filed tax returns for

1979 to 1989 reporting no tax liability.

A. Failure To Cooperate During the Audit

During the late 1980s, the IRS began an examination of

Kanter’s and IRA’s tax returns. Lunk, Transcr. at 1040-1042.

When Kanter met with IRS examiners and they requested certain

documentation, Kanter informed the examiners that he would frame

the issues in the case, not the IRS. Dion, Transcr. at 831-834.
 -214-

In connection with the Kanter examination, IRS agents

interviewed Lisle on January 10, 1990 (Exh. 2030), and Ballard in

February 1990. Lunk, Transcr. at 1040. After these interviews,

the IRS began to examine Lisle’s and Ballard’s tax returns.

It was during this period that (1) Kanter wrote to Ballard’s

and Lisle’s children and explained that he was terminating their

purported consulting agreements, (2) Ballard and Lisle began to

be paid for managing Carlco and TMT, and (3) Kanter began to

negotiate with Ballard and Lisle regarding the loans IRA wrote

off as bad debts in 1987.

During the examination process, Kanter, Ballard, Lisle, and

their associates failed to produce information the IRS requested

orally and/or through written information document requests.

Lunk, Transcr. at 1042-1050, 1059. Kanter produced only

documents related to Schedule A deductions under examination.

Lunk, Transcr. at 1056-1057; Dion, Transcr. at 832-835, 837-838.

Kanter, Ballard, and Lisle failed to produce records sought by

the IRS concerning their grantor trusts and other related

entities. Lunk, Transcr. at 1057-1058.

B. IRS Summonses

The IRS issued summonses to Ballard, Lisle, Schott, and

Gallenberger (in her individual capacity and as an officer of
 -215-

PSAC, which purportedly possessed documents pertaining to Kanter,

Ballard, and Lisle (and related entities)).105

The summons to PSAC dated October 1, 1990, requested, in

part, documents pertaining to PSAC, IRA and its subsidiaries, THC

and its subsidiaries, BWK, and the Bea Ritch Trusts. The summons

requested production of the cash receipts journals, cash

disbursement journals, general ledgers, subsidiary ledgers, and

ledgers for all bank accounts including the TACI Special E

Account. Exh. 9046. The summons also requested production of

documents pertaining to any corporations or partnerships in which

Kanter, his family, and/or his family trusts were shareholders.

Id.

C. Summons Enforcement

In addition to the summonses described above, the IRS served

summonses on Administrative Enterprises, Inc. (predecessor to

PSAC), PSAC, Zion, and BK Children’s Trust (the four Kanter-

related entities) during 1990 and 1991. In 1994, the Government

filed with the U.S. District Court for the Northern District of

Illinois a petition to enforce the four summonses. On April 4,

1994, the District Court issued an order to show cause why the

four Kanter-related entities should not be compelled to comply

with the four summonses. The District Court conducted hearings

105
See app. 16 to this report.
 -216-

related to the Government’s petition on April 20 and May 19,

1994. At the latter hearing, Weisgal testified that at the time

he received the summons served on him as trustee of the BK

Children’s Trust (one of the 25 Bea Ritch Trusts), some of the

documents, including documents relating to the Kanters, had been

turned over to TACI and some documents had been discarded as part

of a 3-year record retention and discard policy. See United

States v. Administration Co., 74 AFTR 2d 94-5252, 94-2 USTC par.

50,479 (N.D. Ill. 1994); Exh. 9047--Mem. Op. and Ord. of May 20,

1994.

Gallenberger testified at the May 19, 1994, hearing that

documents relating to TACI were never returned to her from TACI’s

bankruptcy counsel.106 She testified that many records of PSAC,

Administrative Enterprises, Zion, and the Kanters no longer

existed. Gallenberger testified that she disposed of some

106
During TACI’s bankruptcy proceeding, the only documents
that Korrub, TACI’s bankruptcy counsel, may have received from
TACI were copies of its tax returns. He received none of the
books and records of TACI’s clients. Korrub, Transcr. at 1807-
1808.

In any event, the documents which were the subject of the
IRS summons enforcement proceeding did not include TACI’s tax
returns. The summons sought the books and records of one primary
“client”, namely, the Kanters, relating to transactions involving
the Kanters for 1983, 1985, 1986, 1987, and 1988. United States
v. Administration Co., 74 AFTR 2d 94-5256, 94-2 USTC par. 50,480
(N.D. Ill. 1994), affd. 46 F.3d 670 (7th Cir. 1995). These
records were not given to Korrub; instead, Gallenberger gave them
to Kanter. Gallenberger, Transcr. at 1969-1973.
 -217-

documents after receipt of the IRS summons. United States v.

Administration Co., supra; Exh. 9047--Mem. Op. and Ord. of May

20, 1994.

The District Court concluded that none of the summoned

documents were produced and the Kanters and the four Kanter-

related entities acted in bad faith in failing to comply with and

blocking enforcement of the summonses. The District Court

ordered Gallenberger, on behalf of PSAC, to appear before the IRS

by May 24, 1994, and produce the records sought by the summonses.

United States v. Administration Co., supra; Exh. 9047--Mem. Op.

and Ord. of May 20, 1994.

Although Gallenberger appeared before the IRS and testified

and produced some documents on May 24, 1994, she did not search

all of the records in her possession but instead looked in every

fifth, sixth, or seventh file. On June 10, 1994, the Government

filed with the District Court a motion to hold Gallenberger in

contempt. On June 22, 1994, the District Court held a further

hearing. The District Court noted that PSAC operated much like a

registered agent and a document repository primarily for the

benefit of Kanter-related entities, and most of PSAC’s over 2000

files related to Kanter. United States v. Administration Co., 74

AFTR 2d 94-5256, 94-2 USTC par. 50,480 (N.D. Ill. 1994), affd. 46
 -218-

F.3d 670 (7th Cir. 1995); Exh. 9047--Mem. Op. and Ord. of June

22, 1994, at 3-4.

During the June 22, 1994, hearing, Gallenberger explained to

the court that she produced very few documents because very few

of PSAC’s documents related to transactions between the subject

entities and PSAC. The District Court rejected Gallenberger’s

narrow interpretation of the summons and concluded the summons

fairly encompassed all the documents in the possession of PSAC in

any manner related to the Kanters or Kanter-related entities.

The District Court also concluded that Gallenberger’s sampling of

documents did not discharge her duty to make all reasonable

efforts to comply with the court’s order. Finding a “glaring

deficiency in her compliance”, the District Court, by order dated

June 22, 1994, held Gallenberger in contempt of court and granted

her until July 1, 1994, to purge herself of contempt by fully

complying with the court’s order. United States v.

Administration Co., 74 AFTR 2d 94-5256, at 94-5258, 94-2 USTC

par. 50,480, at 85,772; Exh. 9047--Mem. Op. and Ord. of June 22,

1994, at 4-5.

Gallenberger appealed the District Court’s order of June 22,

1994, holding her in civil contempt, to the Court of Appeals for

the Seventh Circuit. The Court of Appeals affirmed the District
 -219-

Court’s order. See United States v. Administrative Enters., 46

F.3d 670 (7th Cir. 1995).

D. Requests for Production of Documents

PSAC maintained records for Kanter, a number of his family

trusts, and IRA and THC. Before trial, there were “agreements

* * * [between respondent and petitioners] that certain third

party production [records of THC] would be made”. Shortly before

the close of discovery, the agreement fell apart. United States

v. Administration Co., 74 AFTR 2d 94-5252, at 94-5255, 94-2 USTC

par. 50,479, at 85,770. Kanter first promised to produce THC’s

books and records in the possession of PSAC and then, in early

February 1994, notified respondent that the THC records were

records of third parties over whom Kanter had no control. Id.

Kanter’s position was that THC was a third party and discovery on

Kanter was not discovery on THC. Dick, Transcr. at 2509. In the

summons enforcement proceedings, the District Court found that

this “eleventh-hour” change of position by the Kanters was

indicative of bad faith on the part of the Kanters. United

States v. Administration Co., 74 AFTR 2d 94-5252, at 94-5254, 94-

2 USTC par. 50,479, at 85,769.

At the start of the trial in these cases, respondent issued

subpoenas to various Kanter-related entities requesting

production of documents. Exh. 9045. In addition to the books
 -220-

and records of IRA, THC, Carlco, TMT, and BWK, respondent

requested production of documents relevant to determining the

ownership of these entities, including stock ledgers and records

of stockholders. At the start of the trial, Kanter’s counsel

informed the Court that no documents would be produced because

the subpoenas were served on Gallenberger and she was not the

custodian of records for IRA, THC, Carlco, TMT, and BWK. Dick,

Transcr. at 26-27. Kanter’s counsel informed the Court that

Kanter was the custodian of the records in question. Dick,

Transcr. at 26-27. Respondent then served Kanter with subpoenas

for the documents in question. Transcr. at 28.

Petitioners produced complete THC trial balances only for

1980 and 1981. Exhs. 5850, 5851. Respondent possessed from

prior audits (1) partial general ledgers of THC for 1983, 1984,

and 1985, Exhs. 148-150, and (2) partial trial balances of THC

for 1983 and 1984, Exhs. 161-162; Gallenberger, Transcr. at 2510-

2511. There are no complete receipts and disbursement journals,

general ledgers, or trial balances for THC for 1980, 1981, 1982,

1985 (partial), 1986, 1987, 1988, and 1989. Accordingly,

payments made by Schaffel, Frey, and Eulich/Essex Partnership to

THC are not traceable through THC’s books and records.

Gallenberger had in her possession the records of THC for

1986, 1987, and 1988 and at some point turned those records over
 -221-

to Kanter. Gallenberger, Transcr. at 2510, 2713. After

respondent requested production of the THC records, Kanter never

asked Gallenberger for them. Gallenberger, Transcr. at 2517.

Kanter possessed THC’s records but failed to produce them.

Kanter also possessed the books and records of IRA, TMT,

Carlco, and BWK. When respondent requested production of the

records of IRA, TMT, Carlco, and BWK, they had to be retrieved

from Kanter. Gallenberger, Transcr. at 2714-2715.

Gallenberger and Kanter possessed records relevant to

determining the ownership of IRA and THC. At the summons

enforcement hearing, Gallenberger testified that she had the

information available to decide, herself, the ownership of any of

PSAC’s clients. United States v. Administration Co., 74 AFTR 2d

94-5256, 94-2 USTC par. 50,480 (N.D. Ill. 1994); Exh. 9047--Mem.

Op. and Ord. dated June 22, 1994, at 6.

Neither Gallenberger nor Kanter produced stock ledgers for

IRA, THC, Carlco, TMT, or BWK. With respect to Carlco, TMT, and

BWK, the only documents Kanter produced concerning ownership were

copies of initial stock certificates showing that the Kanter,

Ballard, and Lisle family trusts owned the preferred stock of

BWK, TMT, and Carlco, respectively, and a copy of an initial

stock certificate showing that IRA owned the common stock of

these entities. No documentary evidence was introduced to show
 -222-

whether ownership changed from the initial issuance dates of the

stock certificates that Kanter produced.

When the trustees of Kanter’s family trusts, Baskes and

Weisgal, were asked to produce documents, they, likewise, failed

to do so, on the ground that they did not have the requested

information in their possession. Weisgal, Transcr. at 469-470;

Baskes, Transcr. at 574-578.

PSAC had a “policy” of refusing to turn documents over to

anyone other than their owner. Exh. 429; Exh. 9021, at 4;

Gallenberger, Transcr. at 2733-2734.

OPINION

A. The Parties’ Positions

Respondent determined that (1) Kanter, Ballard, and Lisle

earned the moneys The Five paid to IRA, THC, and other Kanter-

related entities during the years at issue; (2) Kanter later

directed and allocated much of that money to himself, Ballard,

and Lisle primarily through BWK (10 percent), TMT (45 percent),

and Carlco (45 percent), respectively; and (3) Kanter and Lisle

shared fees that Schaffel paid to THC on Travelers transactions

(with Lisle receiving a portion of his share through FPC

Subventure Partnership).

Respondent first contends that IRA, THC, Carlco, TMT, BWK,

and other Kanter-related entities were shams and/or nothing more

than the alter egos of Kanter, Ballard, and Lisle. In the
 -223-

alternative, respondent maintains that, by directing The Five to

remit their payments to IRA and THC, and distributing those

payments to Carlco, TMT, BWK, and others, Kanter, Ballard, and

Lisle violated the assignment of income doctrine. Finally,

respondent asserts the Court should reallocate the income in

dispute to Kanter, Ballard, and Lisle pursuant to section 482.107

Petitioners assert the payments from The Five were earned

and properly reported as taxable income by IRA, THC, and other

Kanter-related entities. Petitioners also dispute respondent’s

assertion that the payments from The Five represented kickback

payments to Kanter, Ballard, and Lisle. Petitioners deny that

any kickback scheme existed.

The Commissioner’s deficiency determinations normally are

presumed to be correct, and the taxpayer bears the burden of

proof. Welch v. Helvering, 290 U.S. 111, 115 (1933). On the

other hand, the Commissioner bears the burden of proof with

regard to (1) any increase in the deficiency raised in the

pleadings, and (2) any case involving the issue of fraud with

intent to evade tax. Rule 142(a) and (b); see sec. 7454(a).

There is no dispute the payments from The Five constituted

taxable income to the persons or entities that earned the income.

107
The STJ report, at 84, incorrectly stated that
respondent improperly attempted to raise sec. 482 for first time
on brief. The record reflects that respondent timely raised the
issue in his amendment to answer. In addition, contrary to
petitioners’ arguments, respondent raised this issue on brief.
See Respondent’s Opening Brief at 449-550, 553.
 -224-

Thus, the first issue in these cases is a simple one: Did

Kanter, Ballard, and Lisle earn the payments from The Five?

B. The Assignment of Income Doctrine

In United States v. Basye, 410 U.S. 441, 450 (1973), the

Supreme Court reiterated the longstanding principle that income

is taxed to the person who earns it, stating: “The principle of

Lucas v. Earl, [281 U.S. 111, 115 (1930)], 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.” For a more recent formulation of this

principle, see Commissioner v. Banks, 543 U.S. 426 (2005)

(holding a contingent-fee agreement should be viewed as an

anticipatory assignment to the attorney of a portion of the

client’s income from any litigation recovery).

When payments are remitted to a corporation, as is the case

here, a question may arise whether the corporate entity earned

the income. Generally, a corporate entity will be recognized for

tax purposes. In Moline Props. Inc. v. Commissioner, 319 U.S.

436, 438-439 (1943), the Supreme Court established the following

test for determining whether a corporation will be recognized as

a separate taxable entity:

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
 -225-

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.]

On the other hand, if a corporation (or another legal entity such

as a trust or partnership) was not formed for a substantial

business purpose, and does not engage in actual business

activities, the corporate entity amounts to a sham that may be

disregarded for tax purposes. See Helvering v. Clifford, 309

U.S. 331 (1940); Gregory v. Helvering, 293 U.S. 465 (1935).

Avoiding taxation is not a legitimate business activity in the

normal course. Natl. Investors Corp. v. Hoey, 144 F.2d 466, 468

(2d Cir. 1944).

Even if a corporation is not a sham because it is engaged in

some legitimate business activity, payments to a corporation may

nevertheless be reallocated to another person or entity under the

assignment of income principles mentioned above. In a corporate

context, particularly in cases involving closely held personal

service corporations, the determination of the true earner of

income can be difficult. In Johnson v. Commissioner, 78 T.C.

882, 890-891 (1982), affd. without published opinion 734 F.2d 20

(9th Cir. 1984), a professional athlete who had conveyed the

exclusive rights to his personal services to a corporation

contended that the corporation, rather than he, was taxable on

amounts paid directly to it by his employer. Recognizing that a
 -226-

corporation can act only through its employees and agents, this

Court set forth two requirements that must be met before the

corporation, rather than the service-performing individual, can

be considered to control the earning of the income. These

requirements are: (1) The corporation must have had the right to

direct or control the individual’s activities in some meaningful

manner, and (2) there must exist between the corporation and the

person or entity using the services a contract or similar

indicium recognizing the corporation’s controlling position.

Id. at 890-891.

The U.S. Courts of Appeals for the Seventh Circuit and the

Federal Circuit apply a more flexible facts and circumstances

approach. Schuster v. Commissioner, 800 F.2d 672, 677-678 (7th

Cir. 1986), affg. 84 T.C. 764 (1985); Fogarty v. United States,

780 F.2d 1005, 1012 (Fed. Cir. 1986).

In United States v. Newell, 239 F.3d 917 (7th Cir. 2001),

the Court of Appeals for the Seventh Circuit addressed both the

assignment of income doctrine and concepts of alter ego in a

factual setting analogous to the facts presented in these cases.

In Newell, the taxpayer was president and a 50-percent

shareholder of LPM, Inc. (Inc.), a commodity trader. Pursuant to

a contract, Inc. earned a fee of $1.3 million from a client

during 1993, and the taxpayer directed the client to pay the fee

to LPM, Ltd. (Ltd.), a Bermuda corporation. Neither the
 -227-

taxpayer, Newell, nor Inc. reported the payment to Ltd. as

income. The taxpayer subsequently was convicted of willfully

filing false Federal income tax returns for 1994 for both himself

and Inc.

On appeal, that taxpayer argued in pertinent part that the

Government was improperly allowed to proceed on an assignment of

income theory and the Government failed to prove its case beyond

a reasonable doubt. The taxpayer asserted that Inc. assigned its

contract to Ltd., and, therefore, the $1.3 million payment was

taxable to Ltd. The Court of Appeals rejected the taxpayer’s

arguments.

With regard to the assignment of income doctrine, the Court

of Appeals stated:

To shift the tax liability, the assignor [taxpayer/
Inc.] must relinquish his control over the activity that
generates the income; the income must be the fruit of the
contract or the property itself, and not of his ongoing
income-producing activity. * * * This means, in the case
of a contract, that in order to shift the tax liability to
the assignee the assignor either must assign the duty to
perform along with the right to be paid or must have
completed performance before he assigned the contract;
otherwise it is he, not the contract, or the assignee, that
is producing the contractual income--it is his income, and
he is just shifting it to someone else in order to avoid
paying income tax on it. * * * [Id. at 919-920.]

In addition to these points, the Court of Appeals noted that it

was not entirely accurate for the taxpayer to assert he was

prosecuted under the assignment of income doctrine where it was

not clear there in fact was an assignment and, even if there was,
 -228-

the assignment was a sham inasmuch as the taxpayer attempted to

transfer his income to his alter ego (Ltd.). Id. at 920; see

Leavell v. Commissioner, 104 T.C. 140 (1995) (holding that

compensation paid by Houston Rockets to a wholly owned personal

service corporation of one its players was includable in the

player’s gross income).

Before proceeding, we shall first explain, as completely as

possible, why we have rejected as manifestly unreasonable certain

of the credibility determinations and associated legal

conclusions in the STJ report.

C. Errors in the STJ Report108

The STJ report was based on two fundamental misconceptions

regarding respondent’s position which resulted in (1) compelling

evidence largely being ignored, (2) credibility determinations

regarding The Five that were not relevant to a determination

whether a kickback scheme existed among Kanter, Ballard, and

Lisle, and (3) credibility determinations regarding Kanter,

Ballard, and Lisle that were manifestly unreasonable. A detailed

examination of the substantial record in these cases, along with

a review of the parties’ posttrial briefs, demonstrates that the

ultimate holding recommended in the STJ report, i.e., that

108
We observe at the outset that the STJ report is
organized in an unorthodox fashion. Although organized in
separate sections labeled “General Findings of Fact” and
“Discussion”, the Discussion portion of the report includes
findings of fact that are not contained in the General Findings
of Fact portion of the report.
 -229-

Kanter, Ballard, and Lisle did not participate in a kickback

scheme, is directly contradicted by the overwhelming objective

evidence in these cases and thus is manifestly unreasonable.

As outlined below, the STJ report reflects a fundamental

misunderstanding regarding respondent’s theory as to the means

and manner by which Kanter, Ballard, and Lisle conducted the

kickback scheme. Further, the analysis in the STJ report is

based on the misconception that respondent conceded IRA, THC, and

other Kanter-related entities were not shams. As a result, the

question of the validity of these entities was never broached.

These errors and others are explored in greater detail below.

1. The STJ Report Reflects a Misunderstanding of
Respondent’s Theory Regarding the Kickback Scheme

In rejecting respondent’s assertion that Kanter, Ballard,

and Lisle earned, received, shared, and failed to report as

income a substantial amount of kickback payments, the STJ report,

at 72-77, repeatedly emphasizes that Frey, Schaffel, Schnitzer,

and Eulich uniformly denied that their payments to IRA, THC, and

other Kanter-related entities were intended to compensate Ballard

or Lisle in any way. These statements reveal the STJ report is

based on a fundamental misunderstanding of respondent’s theory

regarding the organization and operation of the kickback scheme.

Respondent argued that Kanter, Ballard, and Lisle did not

disclose their scheme to Schaffel, Frey, Schnitzer, and Eulich.

Respondent’s Opening Brief at 568-567, quoted supra p. 71,
 -230-

included a discussion describing the kickback scheme as a matter

that generally was known only to Kanter, Ballard, and Lisle.

Respondent theorized that Ballard and Lisle agreed to steer

Prudential business to The Five (and Lisle agreed to steer

Travelers business to Schaffel) with the understanding that

Kanter would share with Ballard and Lisle any fees he was able to

obtain from The Five. In other words, respondent conceded that

Schaffel, Frey, Schnitzer, and Eulich were not aware Ballard and

Lisle were using their influence to steer business to them. In

respondent’s view, Schaffel, Frey, Schnitzer, and Eulich simply

agreed to pay Kanter if he was successful in influencing his

clients and other wealthy contacts in the real estate industry to

generate business for them. Having misconstrued respondent’s

position, the STJ report repeatedly cites the testimony of

Schaffel, Frey, Schnitzer, and Eulich as compelling evidence in

support of its conclusion that Kanter, Ballard, and Lisle did not

engage in a kickback scheme.

We acknowledge the STJ report also credits Kanter and

Ballard’s testimony, and Lisle’s statement to IRS agents, that

they were not engaged in a kickback scheme. As we shall discuss

in significant detail below, it was manifestly unreasonable to

give any credence to this testimony.
 -231-

2. Discussion Regarding Assignment of Income

The STJ report, at 81, erroneously states that respondent

conceded IRA, THC, and other Kanter-related entities were not

shams for tax purposes. In fact, Respondent’s Opening Brief at

718 stated in pertinent part:

Respondent asserts that the evidence shows that the
family owned entities [including IRA, THC, TMT, Carlco,
and BWK] should be disregarded as separate taxable
entities. Alternatively, if not disregarded, they are
not taxable on the moneys paid by The Five under the
assignment of income doctrine and the ‘controller of
the income” analysis.

Respondent’s Opening Brief at 719-723 is devoted entirely to the

argument that IRA, THC, and other Kanter-related entities were

shams that should be disregarded for tax purposes.

Proceeding on the misconception that respondent conceded IRA

and THC were valid entities for tax purposes, the STJ report, at

81-82, summarily concludes that the assignment of income doctrine

is inapplicable to payments IRA and THC received from PMS, Essex

Partnership, and Hyatt/KWJ Corp. because “IRA and/or THC owned

the property interests or property rights that generated the

income in question.” No consideration is given to whether IRA’s

and THC’s interests were nominal or illusory. In connection with

the foregoing, the STJ report, at 82-84, concludes the payments

from Frey and Schaffel to IRA and/or THC did not represent an

assignment of income because “IRA and THC * * * exercised
 -232-

significant control over Kanter’s activities”,109 and Frey and

Schaffel both entered “into an agreement to obtain the services

from IRA and/or THC.” Again, no consideration is given to

whether IRA and THC merely served as Kanter’s alter egos.

Because respondent never conceded that IRA and THC were not

shams, these portions of the STJ report are manifestly

unreasonable.110

3. Failure To Address Respondent’s Flow-of-Funds Argument

The STJ report, at 81 note 35, states that respondent’s

kickback theory was “unsupported by the evidence”. What is

lacking, however, is any mention or discussion of respondent’s

detailed flow-of-funds analysis. We can only conclude the STJ

report did not contain an analysis of the flow of funds because

of the misconception that respondent conceded IRA, THC, Carlco,

TMT, BWK, and other Kanter-related entities were not shams. A

thorough evaluation of the evidence concerning the flow of funds

is crucial to a just and proper determination in these cases.

4. Incomplete Discussion Regarding Loan Arrangements

The STJ report, at 78-80, rejects respondent’s argument that

Ballard and Lisle received portions of their shares of the

109
There are no recommended findings of fact in the STJ
report in support of a finding that IRA or THC exercised
significant control over Kanter. As discussed below, the record
shows just the opposite.
110
The question whether IRA and THC were shams also was
particularly relevant to respondent’s determination that Kanter,
Ballard, and Lisle were liable for additions to tax for fraud.
 -233-

kickback payments through loans from IRA to Ballard and Lisle,

their family members, and grantor trusts. Although the STJ

report mentions that loans were extended to Ballard and Lisle,

individually, as well as to their family members, no attempt was

made to quantify those loans, and there is little indication any

consideration was given to respondent’s argument these loans were

shams; i.e., the loans were not properly documented, no principal

or interest was ever paid on the loans, and some of the loans

ultimately were written off as bad debts or sold for $1.

The STJ report, at 79, does include a brief discussion of

the validity of loans to Ballard’s and Lisle’s grantor trusts.

The STJ report, at 79 note 32, rejects Kanter’s testimony that

IRA made nonrecourse loans to Ballard’s and Lisle’s grantor

trusts because the movie investments underlying those loans “were

particularly promising”. The STJ report acknowledges a lender

operating at arm’s length would have demanded some financial

guaranty or collateral from the grantors of those trusts before

extending those loans. The STJ report also acknowledges that

Ballard and Lisle were valuable business contacts to Kanter and

Kanter traded on those contacts to obtain “business arrangements

with other third parties”. Id. at 79. Despite these

observations, the STJ report simply concludes Kanter “may have

helped to arrange favorable loans for Ballard and Lisle out of

gratitude for their friendship and the business advantages that
 -234-

friendship conferred” upon Kanter.111 Id. at 80. A detailed

analysis of the magnitude, validity, and treatment of all loans

that Ballard, Lisle, and their grantor trusts received from IRA,

IFI, BWK, and other Kanter-related entities is lacking in the STJ

report.

5. Discussion Regarding Consulting Payments to Ballard’s
and Lisle’s Adult Children

Much like the loan discussion outlined above, the STJ

report, at 80-81, acknowledges Kanter may have considered the

consulting arrangements with Ballard’s and Lisle’s adult children

to be “favors” to Ballard and Lisle. The STJ report then

rationalizes the consulting payments by pointing out that Ballard

and Lisle managed TMT’s and Carlco’s assets at no charge to IRA

until 1990. Significantly, although recognizing the possible

relationship between the consulting payments to the Ballard and

Lisle children and Ballard’s and Lisle’s management of TMT and

Carlco, the STJ report fails to explore the circumstances

surrounding Kanter’s termination of the consulting payments in

1990 and Kanter’s nearly simultaneous decision to begin

compensating Ballard and Lisle for managing TMT and Carlco. At

the very least, these circumstances raised the question whether

111
The STJ report, at 80 note 34, also refers to FPC
Subventure Partnership as another example of a favorable
transaction between Kanter and Lisle, and it acknowledges that
the record fails to disclose whether Lisle repaid Kanter for his
90-percent interest in that partnership. However, the STJ report
does not contain any further recommended findings of fact with
respect to this transaction.
 -235-

the consulting payments constituted income assigned by Ballard

and Lisle to their children. As discussed in detail infra pp.

293-295, a close examination of Kanter’s letters terminating the

consulting payments to the children is indicative of an attempted

coverup of that question.

6. Manifestly Unreasonable Credibility Determinations

a. Testimony Offered by The Five

As previously discussed, because respondent asserted that

Kanter, Ballard, and Lisle did not disclose their kickback scheme

to Schaffel, Frey, Schnitzer, and Eulich, the conclusion in the

STJ report that The Five testified credibly that they did not

intend for their payments to IRA or THC to serve as kickbacks to

Ballard and Lisle is not dispositive of the matter.

b. Ballard’s Testimony Regarding the Hyatt Transaction

The STJ report, at 76 note 29, states that Ballard’s

testimony that he discussed the Hyatt/KWJ fee agreement with A.N.

Pritzker “dispels the notion that there was collusion between

Ballard, Lisle, Kanter, and Weaver with respect to [Weaver’s

finder’s] fees.” Ballard’s testimony lacked credibility. First,

the testimony was self-serving on its face and uncorroborated by

any other witness. Second, A.N. Pritzker seemed intent upon

keeping the Hyatt/KWJ agreement a secret, even within the

Pritzker family, and, therefore, it seems implausible that A.N.

Pritzker would have spontaneously volunteered this information to
 -236-

Ballard, or anyone else at Prudential. Ballard did not offer any

explanation why A.N. Pritzker revealed the information to him.

Finally, even assuming Ballard had such a conversation with A.N.

Pritzker, indignation was the natural reaction any forthright

Prudential executive would have had to the disclosure. Ballard’s

indignation, however, was feigned. A critical examination of the

flow of funds clearly and convincingly shows that Ballard earned

and received a share of the Hyatt Corp. payments under the

Hyatt/KWJ agreement after the payments passed through IRA, KWJ

Partnership, and TMT. Ballard had unfettered use, enjoyment, and

control over TMT’s funds, and he surely did not want to disclose

his role in the Hyatt transaction to A.N. Pritzker. Thus, the

recommended conclusion in the STJ report that Ballard’s testimony

was sufficient to dispel the notion there was “collusion” among

Ballard, Lisle, Kanter, and Weaver with regard to the payments

that Hyatt Corp. remitted to KWJ Corp. was manifestly

unreasonable.

c. Kanter’s Testimony Regarding Deconsolidation

The STJ report, at 81 note 35, treats as credible Kanter’s

testimony that Carlco, TMT, and BWK were removed from IRA’s

consolidated group for tax-reporting purposes because Kanter was

concerned about the impact of Carlco’s investments in tax-exempt

bonds on IRA’s interest deductions. While Kanter’s explanation

may have seemed plausible with regard to Carlco, it did
 -237-

absolutely nothing to explain why it was necessary or desirable

to remove TMT and BWK from IRA’s consolidated group. Considering

all the circumstances surrounding Carlco, TMT, and BWK, see

discussion infra pp. 278-288, Kanter’s testimony lacked

credibility. Carlco, TMT, and BWK were removed from IRA’s

consolidated group in 1984 to reflect the reality that those

entities were owned and controlled by Lisle, Ballard, and Kanter,

respectively, and each would be responsible for its own tax

liabilities going forward.

d. Kanter’s Testimony Regarding IRA

The STJ report, at 83 note 36, treats as credible Kanter’s

testimony that he served as an adviser, attorney, and consultant

to IRA and he made recommendations to Freeman and Weisgal, who

made final decisions regarding IRA’s investments. This

credibility determination was manifestly unreasonable inasmuch as

(1) Kanter conceded that, for several years during the 1980s,

Freeman was too concerned with his own legal woes to manage IRA,

and (2) Weisgal could recall little about IRA’s operations. As

discussed infra pp. 276-278, IRA was simply Kanter’s alter ego,

and Kanter’s testimony to the contrary lacked credibility.

e. Kanter’s, Ballard’s, and Lisle’s Denials

The STJ report, at 72-81, treats as credible Kanter’s and

Ballard’s testimony, and Lisle’s statement to IRS agents, that

they were not engaged in a kickback scheme during the years at
 -238-

issue. As discussed in detail below, these credibility

determinations were manifestly unreasonable because there is

overwhelming objective evidence of record, particularly through a

critical evaluation of the flow of funds, which demonstrates that

with so-called capital contributions, loans that were never

repaid, and other payments to Kanter, Ballard, and Lisle and

their families, IRA transferred to Carlco and/or Lisle, TMT

and/or Ballard, and BWK and/or Kanter, in a roughly 45/45/10

percent split, all of the payments from The Five (and nothing

more). The flow-of-funds analysis also demonstrates that Kanter,

Ballard, and Lisle had unrestricted use and enjoyment of the

assets IRA transferred to BWK, TMT, and Carlco, and they treated

those assets as their own. Similarly, the flow-of-funds analysis

demonstrates that Kanter and Lisle shared the payments that The

Five made to THC.

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

1. An Overview

The record in these cases presents an overwhelming amount of

testimony and documentary evidence in support of respondent’s

determinations that Kanter, Ballard, and Lisle earned income in

the form of the payments from The Five that were remitted to IRA,

THC, and their subsidiaries. Consistent with our findings of

fact as set forth above, and all the inferences that fairly may

be drawn from those facts, we conclude the statements in the STJ
 -239-

report to the effect that Kanter, Ballard, and Lisle testified

credibly they were not engaged in a kickback scheme during the

years at issue are manifestly unreasonable.

We have often emphasized that fraud may be proved by

circumstantial evidence because direct evidence of fraud

generally is not available. See, e.g., Niedringhaus v.

Commissioner, 99 T.C. 202, 210 (1992). More often than not (and

as is certainly the case here), fraud can be established only

through circumstantial evidence and the inferences to be drawn

therefrom. See, e.g., DiLeo v. Commissioner, 96 T.C. 858, 874

(1991).

There is direct evidence the payments from The Five to IRA

and THC represented income earned by Kanter. The transactions in

question in these cases, however, were carried out in such a way

that respondent must rely on circumstantial evidence in support

of his determination that Ballard and Lisle earned substantial

portions of the payments from The Five. There is no direct

evidence that Kanter, Ballard, and Lisle agreed to share the

payments from The Five, nor is there much in the way of direct

evidence that Ballard and Lisle used their influence to steer

Prudential or Travelers business to The Five. As explained

below, however, there is plenty of evidence that Kanter, Ballard,

and Lisle had the opportunity and wherewithal to carry out the

alleged scheme. Ballard and Lisle certainly were in a position
 -240-

to influence Prudential and Travelers to award business to The

Five, and to varying degrees they were directly involved in the

decisions that led to Prudential’s and Travelers’ business

dealings with The Five. Those factors, in combination with the

flow of funds–-the fairly precise division of the proceeds of the

scheme among the three--remove all doubt in these cases in

respondent’s favor. We conclude that all the circumstances, when

gathered together and viewed as a whole, constitute compelling

and unmistakable evidence that Kanter, Ballard, and Lisle earned

the income in question and Kanter’s and Ballard’s conduct in

these matters was fraudulent.112

Kanter, an experienced and knowledgeable tax attorney,

established a complex web of corporations, partnerships, and

trusts as part of a plan to receive, disguise, launder, and

distribute payments from The Five to himself, Ballard, and Lisle.

The complex laundering mechanism of sham corporations and other

entities that Kanter put together included among others IRA, THC,

Carlco, TMT, BWK, KWJ Partnership, Essex Partnership, Zeus, IFI,

HELO, TACI, and PSAC.

Ballard and Lisle were sophisticated and experienced

businessmen who held two of the highest ranking executive

positions within the real estate division at Prudential’s

112
The Court of Appeals for the Fifth Circuit has already
ruled that Lisle is not liable for additions to tax for fraud.
Estate of Lisle v. Commissioner, 341 F.3d 364 (5th Cir. 2003).
 -241-

national headquarters. Ballard later was a partner at Goldman

Sachs. Lisle later held the highest ranking executive position

within the real estate division at Travelers. Kanter, Ballard,

and Lisle fully understood and appreciated their obligations to

report income correctly and to pay taxes on that income. It was

a conflict of interest for Ballard or Lisle to have received

compensation in any way (directly or indirectly) with funds

Kanter received in connection with introductions he made to

Ballard or Lisle. Exh. 2030, at 31.

Kanter had many influential clients and business contacts

involved in commercial property management and major hotel

management businesses. Kanter represented the Pritzkers (the

founders of Hyatt Corp.) and had longstanding friendships with

Ballard and Lisle. Thus, Kanter marketed himself as more than

just an attorney to his clients and commercial real estate

professionals–-he offered additional services such as raising

capital and using his influential contacts to generate business.

In return for these services, Kanter demanded and routinely

received a percentage or share of the fees and profits that the

business opportunities generated for his business associates.

Beginning in the early to mid-1970s, Kanter, Ballard, and

Lisle concluded that, with Ballard’s and Lisle’s positions of

authority at Prudential, and Kanter acting as a broker/
 -242-

intermediary, the three together could generate and share

enormous fees and profits. The three men recognized that

Kanter’s skills as an attorney, combined with his client list and

business contacts in the commercial real estate industry, neatly

complemented Ballard’s and Lisle’s ability to influence

Prudential’s business decisions pertaining to its large

commercial real estate holdings throughout the country.

Accordingly, without disclosing Ballard’s and Lisle’s direct

roles in the scheme, Kanter approached various businessmen,

including Schaffel, Frey, Schnitzer, and Eulich, and offered to

assist them in raising capital and/or obtaining property

management contracts for their businesses in exchange for a share

in the fees or profits generated by these business opportunities.

Although Kanter arranged to have these fees and profits paid to

IRA or THC (or their subsidiaries), Schaffel, Frey, Schnitzer,

and Eulich uniformly stated that they were relying on Kanter, and

Kanter alone, to provide them with the additional business

opportunities they were seeking. Largely unbeknownst to

Schaffel, Frey, Schnitzer, and Eulich, however, Kanter, Ballard,

and Lisle had agreed to share any fees and profits paid to Kanter

to the extent that Ballard and Lisle were able to exert their

influence to steer Prudential business to Kanter’s contacts.

Considering their relative positions, Kanter, Ballard, and

Lisle agreed to share the fees and profits 45 percent each to
 -243-

Ballard and Lisle and 10 percent to Kanter. Kanter’s smaller

share of the payments reflected the fact that Ballard and Lisle

really controlled the purse strings and Kanter’s role primarily

was to (1) set up fee-sharing arrangements with other

businessmen, and (2) structure entities and arrange the

accounting measures needed to disguise the true nature of the

payments, and (3) do his best to shelter the payments from

Federal income tax. Kanter and Lisle agreed to a similar

arrangement after Lisle moved on to Travelers.

In addition to his agreement with Ballard and Lisle, Kanter

arranged some transactions so that he could be compensated

separately through payments to THC. Kanter made such

arrangements with regard to transactions with Frey and Eulich.

The Hyatt transaction, the event that first brought Kanter,

Ballard, and Lisle together in the early 1970s, was carried out

in a slightly different fashion, as we shall explain in detail

below.

The Five received additional business as a result of

Kanter’s, Ballard’s, and Lisle’s efforts and compensated Kanter

(through payments to IRA, THC, and other Kanter-related

entities). IRA, THC, and the other Kanter-related entities did

not earn any of the amounts paid to them by The Five. IRA, THC,

and the other Kanter-related entities performed no services, and

they merely served as nominees or conduits to receive payments
 -244-

from The Five. With regard to the transactions with The Five,

Kanter was not an agent, officer, or employee of IRA or its

subsidiaries during the years at issue, except in 1989 after the

IRS began its investigation. Kanter was not controlled by IRA.

To the contrary, Kanter controlled IRA.

The payments from The Five were distributed by various means

either directly to Ballard, Lisle, and Kanter or indirectly

through loans, investments, or consulting payments to them, their

family members, or trusts and/or other entities established for

the benefit of their families. To conceal Ballard’s and Lisle’s

involvement in the scheme, and in an attempt to avoid having to

report the amounts earned from the scheme on their individual tax

returns, Kanter established TMT to serve as Ballard’s alter ego,

and Carlco to serve as Lisle’s alter ego. The funds that Kanter

transferred to TMT and Carlco were Ballard’s and Lisle’s shares

of the fees and profits earned on the transactions with The Five.

Ballard and Lisle owned TMT and Carlco, respectively, and they

had unfettered use and enjoyment of the assets held nominally by

those corporations. FPC Subventure Partnership was a conduit

through which Kanter passed to Lisle his share of fees paid to

Kanter by Schaffel in regard to Travelers transactions.

2. The Hyatt Transaction

Kanter first met Lisle in the late 1960s, and he met Ballard

no later than the early 1970s, in connection with the
 -245-

construction and opening of the Houston Hyatt Hotel. Ballard and

Lisle had been involved in the development of the Houston Hyatt

Hotel as Prudential representatives. Kanter was connected to the

project through his representation of the Pritzker family and the

award to Hyatt Corp. of the management contract for the hotel.

J.D. Weaver was also involved in this project as a representative

of Tenneco, which had partnered with Prudential to construct the

hotel.

After winning the Houston Hyatt Hotel management contract,

A.N. Pritzker wanted to submit a bid for Hyatt Corp. on the

Embarcadero Hotel management contract. Lisle, however, was

opposed to such a bid because Hyatt Corp. was proposing to build

another hotel in the San Francisco area. A.N. Pritzker somehow

came to believe that Weaver might be able to influence Lisle to

allow Hyatt Corp. to submit a bid on the Embarcadero Hotel. In

this regard, A.N. Pritzker agreed with Weaver that if Weaver

could persuade Lisle to allow Hyatt Corp. to submit a bid on the

contract, and if Hyatt Corp. were awarded the Embarcadero Hotel

management contract, Hyatt Corp. would pay Weaver 10 percent of

Hyatt Corp.’s profits on the management contract.

Lisle and Ballard were both present at the Embarcadero Hotel

bid meeting. Ballard was assigned to attend the Embarcadero

Hotel bid meeting and evaluate the various bids.
 -246-

Weaver’s effort to influence Lisle was successful.

Unexpectedly, Intercontinental Co., one of the bidders, withdrew

at the last minute and did not attend the bid meeting. A second

bidder, Del Webb, who surprisingly attended the meeting in person

(as opposed to sending a representative), refused to submit a bid

because he believed he had already been awarded the contract. In

the absence of a competing bid, Hyatt Corp. was awarded the

Embarcadero Hotel management contract on the same terms on which

it had agreed to manage the Houston Hyatt Hotel.

The record reflects that Weaver did much more than simply

influence Lisle to permit Hyatt Corp. to submit a bid on the

Embarcadero Hotel management contract. After Hyatt Corp. won the

Embarcadero Hotel management contract, Hyatt Corp. entered into

an agreement to pay 10 percent of Hyatt Corp.’s annual “net cash

profits” from the contract to KWJ Corp., Weaver’s closely held

corporation. The Hyatt/KWJ agreement stated that Weaver “has

been the principal factor in bringing the parties together and

aiding in the negotiations” with regard to the Embarcadero Hotel

management contract. In addition, the Hyatt/KWJ agreement was

executed under the unusual circumstances that initially only A.N.

Pritzker and his two sons knew the agreement existed. When other

Hyatt Corp. executives later investigated the matter (including

Friend--A.N. Pritzker’s son-in-law), they determined the

Hyatt/KWJ agreement represented a reward to Weaver for his
 -247-

“substantial influence” in “arranging the management agreement”

on the Embarcadero Hotel between Hyatt Corp. and Prudential.

We infer from all the facts and circumstances that Weaver

recognized he would gain nothing by simply persuading Lisle to

permit Hyatt Corp. to bid on the Embarcadero Hotel management

contract. Weaver would be compensated only if Hyatt Corp. were

to win the bidding on the contract. Consequently, Weaver

informed Lisle and Ballard of A.N. Pritzker’s promise to pay 10

percent of the Embarcadero Hotel management contract to Weaver,

and Weaver agreed to share any payments he might receive from

Hyatt Corp. with Ballard and Lisle if they used their influence

to arrange for Hyatt Corp. to win the contract. Lisle and

Ballard agreed to Weaver’s proposal, and they arranged for Hyatt

Corp. to win the contract. That Weaver did more than simply

persuade Lisle to permit Hyatt Corp. to bid on the Embarcadero

Hotel contract is evidenced by the Hyatt Corp. internal documents

which stated that Weaver “arranged” the contract for Hyatt Corp.

The record indicates Kanter became aware of the Hyatt/KWJ

agreement in the early 1970s when A.N. Pritzker presented the

matter to him seeking advice. During this same period, Kanter

was assisting Ballard and Lisle in establishing the grantor

trusts they would use to invest in his movie shelters, and Kanter

initiated discussions with Weaver regarding the sale of KWJ Corp.

to IRA. We infer from the timing of these events that Kanter
 -248-

learned that Weaver agreed to share with Lisle and Ballard any

payments that KWJ Corp. might receive under the Hyatt/KWJ

agreement, and Kanter was offered a share of these payments in

exchange for structuring the receipt and disbursement of the

payments to the participants in a manner that would conceal

Lisle’s and Ballard’s involvement in the matter. In particular,

Kanter arranged IRA’s purchase of KWJ Corp., the liquidation of

KWJ Corp., and the formation of KWJ Partnership.

The transfer of KWJ Corp. to IRA was facilitated under the

cover of an open-ended option (with no apparent independent

value) that Weaver granted to IRA in 1976 to purchase KWJ Corp.

for $150,000. Kanter’s testimony that Weaver entered into this

option agreement because he needed the money is wholly

discredited by the fact that Weaver received nothing under the

option agreement until mid-1980-–4 years later.

Although there was some initial discord between Hyatt Corp.

and Weaver regarding the payments that KWJ Corp. would receive

under the Hyatt/KWJ agreement, we attribute this development to

the Pritzkers’ reputation as aggressive negotiators who wanted to

pay as little as possible to KWJ Corp. Nevertheless, Hyatt Corp.

did pay substantial sums to KWJ Corp. pursuant to the Hyatt/KWJ

agreement, and, as described in the flow-of-funds analysis below,

approximately 70 percent of those payments were transferred

through IRA to KWJ Partnership and on to Carlco, TMT, and BWK in
 -249-

a 45/45/10 percent split. KWJ Partnership was also used as a

conduit to transfer funds to Ballard’s and Lisle’s adult children

in the form of so-called consulting payments.

Kanter, Ballard, and Lisle earned the income associated with

the portion of the Hyatt Corp. payments that were routed through

IRA and KWJ Partnership. Kanter, Ballard, and Lisle attempted to

assign that income to IRA and later to KWJ Partnership and its

partners, Carlco, TMT, and BWK. Kanter, Ballard, and Lisle

failed to report this income on their own tax returns.

Through the Hyatt transaction, Kanter, Ballard, and Lisle

came to realize that Kanter’s skills as an attorney, his client

list, and his business contacts in the commercial real estate

industry neatly complemented Ballard’s and Lisle’s ability to

influence Prudential’s business decisions pertaining to its large

commercial real estate holdings throughout the country. The

Hyatt transaction set the stage for Kanter’s, Ballard’s and

Lisle’s dealings with Schaffel, Frey, Schnitzer, and Eulich,

summarized below.

3. Schaffel

In the late summer of 1979, Schaffel met Kanter, Ballard,

and Lisle for dinner in New York. Lisle understood that Kanter

arranged the dinner in part to see whether Schaffel might be able

to do business with Prudential. Shortly thereafter, Schaffel

agreed to share with Kanter any fees he might earn on
 -250-

construction contracts between Prudential and Torcon. In the

early fall of 1981, Schaffel also agreed to share with Kanter any

fees he might earn on financing that Prudential might provide for

Walters’s development projects. Kanter agreed to share with

Ballard and Lisle any fees he might receive from Schaffel if they

used their influence at Prudential to award construction

contracts to Torcon or to provide financing for Walters’s

projects.

While Ballard and Lisle were still employed at Prudential,

Schaffel received (1) real estate broker’s fees on the sale of

IBM’s headquarters building to Prudential, (2) fees related to

Prudential construction contracts awarded to Torcon, and (3) fees

related to financing that Prudential provided for Walters’s

development projects. Schaffel shared these fees with Kanter by

way of payments to IRA.

Although some of the Prudential transactions that generated

fees for Schaffel were initiated after Ballard and Lisle left

Prudential, the inference may fairly be drawn that those

transactions were an outgrowth of Ballard’s and Lisle’s earlier

decisions to do business with Schaffel, which allowed Schaffel

(and his clients) to establish a favorable reputation with

Prudential.

In 1982, Lisle left Prudential and accepted a position as

the head of Travelers’ real estate department. Pursuant to his
 -251-

agreement with Kanter, Lisle assisted Schaffel by approving a

number of financing deals between Travelers and Walters for

various development projects. Schaffel remitted one payment to

IRA arising from a Travelers financing deal that he brokered

shortly after Lisle began working at Travelers. Schaffel then

balked at making any additional payments to IRA. A dispute

between Schaffel and Kanter ensued, and Kanter convinced Schaffel

that he was obliged to continue to share with Kanter any fees and

commissions that he might earn on Travelers financing

transactions. At this point, Schaffel did not want to remit any

further payments to IRA, and Kanter directed Schaffel to make his

payments to THC.

Although Schaffel remitted his payments to either IRA or

THC, those entities were used only as conduits to appease

Schaffel’s concerns over the legality of sharing broker’s fees

with a nonbroker. There is no evidence in the record that anyone

representing IRA or THC was “instrumental or helpful” in

obtaining financing from Prudential or Travelers for Walters’s

development projects or in obtaining Prudential construction

contracts for Torcon.

Schaffel understood that Kanter himself would exert

influence in an attempt to obtain Prudential and Travelers

business for Schaffel and his clients. We conclude Kanter

obtained such business from Prudential with the help of Ballard
 -252-

and Lisle, and from Travelers with the help of Lisle. There is

no direct evidence that Kanter agreed to share with Ballard and

Lisle any payments he might receive from Schaffel. However, a

number of factors, including the dinner meeting in New York,

Ballard’s immediate role in Prudential’s purchase of the IBM

building, Ballard’s and Lisle’s ability to influence Prudential’s

awards of construction contracts to Torcon and financing

transactions for Walters’s projects, Lisle’s direct role in

awarding Travelers financing for Walters’s projects, the details

concerning the Kanter/Schaffel fee dispute, and the divisions of

the Schaffel payments made to IRA and THC as discussed in the

flow-of-funds analysis below, provide compelling circumstantial

evidence that Kanter, Ballard, and Lisle agreed to share the

Schaffel payments. Consequently, for tax purposes, Kanter,

Ballard, and Lisle were the true earners of the fees that

Schaffel paid to IRA on Prudential transactions, and Kanter and

Lisle were the true earners of the fees that Schaffel paid to IRA

and THC on Travelers transactions.

Kanter used IRA as a repository for the Schaffel payments

and as a conduit to channel the payments to himself, Ballard, and

Lisle. Kanter, Ballard, and Lisle attempted to assign to IRA the

income they earned from Schaffel, and they failed to report their

shares of that income on their individual returns. As discussed

in the flow-of-funds analysis below, Kanter later transferred
 -253-

Ballard’s and Lisle’s shares of the fees that Schaffel paid to

IRA to them through TMT and Carlco, and he received his own share

through BWK.

Kanter and Lisle attempted to assign income that they earned

on Travelers transactions to THC, and they failed to report that

income on their individual returns. There is insufficient

evidence to demonstrate that funds that Schaffel paid to THC were

distributed directly to Lisle. Nevertheless, as discussed in the

flow-of-funds analysis below, Kanter transferred at least a

portion of Lisle’s share of Travelers fees to Lisle through FPC

Subventure Partnership.

4. Frey

Frey was a real estate developer engaged in condominium

conversion projects. Condominium conversion projects generally

were capital intensive enterprises. Kanter told Frey that he

could bring investors with substantial capital to Frey’s

condominium conversion projects but that he would only do so if

Frey provided Kanter with an equal share of any development and

management fees generated by the conversion projects. Frey

orally agreed to this arrangement. Although he remitted Kanter’s

share of development and management fees to THC as directed by

Kanter, Frey understood that it was Kanter who would bring the

deep-pocket investors to his projects.
 -254-

Kanter also arranged for subsidiaries of IRA (Zeus) and of

THC (Zion) to invest in some of Frey’s projects as limited

partners.

In early 1980, Ballard approved the sale by a pension fund

managed by Prudential of a large apartment complex in Florida

known as Village of Kings Creek to a limited partnership

organized by Frey. Ballard visited the project during the

conversion period. Frey was very successful in converting the

property to condominiums. Shortly thereafter, in the fall of

1981, Prudential entered into a several joint venture condominium

conversion projects with Frey (under which Frey managed the

conversion of Prudential properties into condominiums).

At this time, Kanter and Frey committed their earlier oral

fee-sharing agreement to writing. The Frey/THC participation

agreement provided that for condominium conversion projects

involving Prudential properties, and any future condominium

conversion projects not involving Prudential properties, THC and

Frey would participate in capital contributions and profits and

losses as 33-percent and 67-percent partners, respectively. In

addition, after October 1, 1981, THC would receive 5 percent of

any development fees derived from any condominium conversion

projects not involving Prudential properties. Frey agreed to

share development fees with THC as a way to compensate Kanter for
 -255-

bringing investors and capital to his condominium conversion

projects.

The Frey/Zeus agreement formalized Frey’s and Kanter’s prior

oral agreement to share development fees and expanded that

agreement to include “assigned profits” on Prudential condominium

conversion projects. In particular, Frey agreed to remit to Zeus

a 5-percent share of development fees and a 20-percent share of

assigned profits earned on Prudential conversion projects because

Kanter promised to use his influence to aid Frey in obtaining

additional condominium conversion projects from Prudential.

There is no direct documentary evidence that Kanter agreed

to share with Ballard and Lisle any payments he might receive

from Frey. Nevertheless, considering all the circumstances,

including Ballard’s role in the Village of King’s Creek

transaction, the numerous Prudential projects initiated with Frey

in the fall of 1981, and the division of the Frey payments as

discussed in the flow-of-funds analysis below, we infer Kanter

surreptitiously agreed with Ballard and Lisle that if they used

their positions of authority at Prudential to influence

Prudential to contract with Frey as the developer in the

conversion of Prudential properties, Kanter would share with

Ballard and Lisle the development fees and assigned profits

payments that he expected to receive from Frey. Kanter also

agreed to share with Ballard and Lisle any profits that Zeus
 -256-

might make by participating as a limited partner in various Frey

partnerships.

The Frey-Zeus agreement reflected Frey’s recognition that

Kanter’s influence in delivering several Prudential condominium

projects in the summer and fall of 1981 was extremely valuable.

At a time when investors were aggressively competing for

properties to convert to condominiums and for capital to complete

those conversions, Prudential provided a ready supply of such

properties, and these projects did not require large infusions of

capital.

In 1984, Frey, Kanter, and others formed BJF Partnership to

engage in condominium conversion projects. The BJF Partnership

agreement included a list of assets that the partners contributed

to the partnership. Among the listed items were two

participation agreements--the Frey/THC agreement and the

Frey/Zeus agreement dated October 21, 1981. Kanter, acting on

behalf of THC, transferred to BJF Partnership rights to the

Frey/Zeus agreement. Kanter, however, asserts that he neither

owned nor controlled IRA or Zeus.

Frey made payments to Zeus and THC. By directing Frey to

make payments to Zeus on Prudential condominium conversion

projects, Kanter, Ballard and Lisle attempted to assign income

that they earned on those projects to Zeus. By directing Frey to
 -257-

make payments to THC, Kanter attempted to assign income that he

earned on non-Prudential condominium conversion projects to THC.

5. Schnitzer/PMS

Schnitzer was interested in increasing the number of

property management contracts awarded to PMS, a subsidiary of

Century, a company he controlled. To this end, in 1974,

Schnitzer approached Ballard (with whom Schnitzer had previously

dealt in developing office buildings in Houston, Texas) and

offered to give Prudential a 50-percent stock interest in PMS.

Although Prudential ultimately declined Schnitzer’s offer, from

1974 through 1977 PMS’s property management business increased

substantially, with a large percentage of its contracts coming

from Prudential.

In 1977, Schnitzer and Kanter discussed Century’s possible

sale of a 47.5-percent stock interest in PMS to IRA. Kanter told

Schnitzer that he had various business contacts, including the

Pritzker family, through which Kanter could obtain additional

property management business for PMS. Before agreeing to sell

PMS’s common stock to IRA, Schnitzer conferred with Ballard to

obtain his view as to whether Kanter could deliver additional

management contracts for PMS. In November 1977, Century sold a

47.5-percent stock interest in PMS to IRA at a bargain price of

$150,000.
 -258-

Schnitzer and Ross were not relying on IRA, Schott, or

Weisgal to generate additional business opportunities for PMS.

Schnitzer and Ross were relying solely on Kanter to obtain

additional business opportunities for PMS.

During the period 1976 to 1979, PMS expanded its portfolio

of management contracts, and its growth was attributable in large

measure to additional contracts from Prudential, which

represented approximately 40 percent of its revenue.

In late March 1979, Schnitzer informed Kanter that he was

disappointed with Kanter’s failure to deliver additional property

management business for PMS, and he wanted to buy back the PMS

stock held by IRA. Kanter made a counteroffer to purchase all of

the PMS stock that Schnitzer owned for $3.1 million. Ultimately,

Schnitzer agreed to pay IRA $3.1 for its PMS stock with payments

to be made in installments over 10 years. In February 1989, PMS

made an early, discounted final payment to PSAC, which

transferred the funds to IRA for distribution to Carlco, TMT, and

BWK.

Once again, although there is no direct evidence of an

agreement among Kanter, Ballard, and Lisle to share profits from

the PMS transaction, the surrounding circumstances strongly

support an inference that an agreement was in place. We begin

with the fact that Ballard and Lisle were aware that Schnitzer

was so anxious to expand PMS’s management business that he was
 -259-

willing to part with a large share of the company at a bargain

price. Against this backdrop, Schnitzer conferred with Ballard

before agreeing to sell a large stake in PMS to IRA. Ballard and

Lisle, of course, were in a position to increase PMS’s portfolio

of Prudential management contracts. Considering that the PMS

installment payments eventually were divided among Carlco, TMT,

and BWK (as discussed in the flow-of-funds analysis below), we

infer that Kanter, Ballard, and Lisle recognized they could earn

easy profits by acquiring stock in PMS, and they agreed to share

those profits before IRA acquired the PMS stock.

Kanter, Ballard, and Lisle used IRA as a conduit to obtain a

47.5-stock interest in PMS and to conceal Ballard’s and Lisle’s

involvement in the matter. The substantial appreciation that IRA

realized between the $150,000 purchase price for the PMS stock in

November 1977 and the $3.1 million sale price in August

1979-–the latter amount being paid in installments over 10

years--represented income that was earned by Kanter, Ballard, and

Lisle. Kanter, Ballard, and Lisle improperly attempted to assign

income from the PMS transaction to IRA. As discussed in the

flow-of-funds analysis below, Kanter shared the income derived

from the PMS stock sale with Ballard and Lisle through

distributions to TMT, Carlco, and BWK.
 -260-

6. Eulich/Essex Partnership

Eulich was interested in obtaining management contracts for

large hotels for his company, MHM, and in 1981 he approached

Kanter for assistance in this regard.113 At the time, MHM was

managing one large hotel (the Madison Hotel) in New Jersey. In

August 1981, MHM was awarded a contract to manage another large

hotel, the Allentown Hilton.

Beginning in the fall of 1981 and into early 1982, Kanter

and Eulich organized Essex Corp. and Essex Partnership. The

organization of these entities coincided with Prudential’s

decision to award the management contracts for the Gateway Hilton

(fall 1981) and the Midland Hilton (no later than February 1982)

to Connolly (the onsite manager of the Gateway Hilton). Ballard

and Lisle were instrumental in awarding these contracts to

Connolly, even though they knew that Connolly did not have the

support services (personnel) to manage the hotels on his own.

113
Eulich testified in pertinent part:

Kanter was the person whose influence and contacts that
we wanted at MHM because of his--again, his involvement
as one of the founders of Hyatt International, his
involvement with the Pritzkers, and his involvement,
significant involvement with this Mullett Bay Resort.

I mean, the man--he knew a lot of people in the
hotel business, and he knew people who owned the types
of properties that we wanted, and we were not able to
attract, because we were running the two-story, you
know, freeway-oriented motels. [Eulich, Transcr. at
1633-1634.]
 -261-

Ballard introduced Eulich to Connolly as someone who would

assist Connolly with the support services he needed to properly

manage the Gateway Hilton. Eulich then organized Gateway Hotel

Management Co. (GHM) to make it appear as if Connolly was the

owner of a hotel management company. In early 1982, Connolly and

Essex Corp. executed the GHM option agreement, which they

purportedly agreed to on September 18, 1981, and which recited

that (1) Connolly owned 100 percent of GHM, (2) Connolly was

transferring to Essex Corp. an option to acquire 80 percent of

GHM (80 shares at $100 per share) for 10 years and, (3) in

exchange for the option, Essex Corp. would pay Connolly $1,000

per year for 10 years. The record also includes the Connolly

promissory note dated December 15, 1981, from Connolly to Essex

Corp., in the amount of $8,000, subject to 8 percent interest,

payable for 9 years with a final balloon payment due in 1991.

Because the payments under the Essex option offset the amounts

due from Connolly under the promissory note, we infer that these

transactions were nothing more than a sham to make it appear that
 -262-

Connolly had adequately capitalized GHM.114 At best, GHM was

capitalized with $2,000.

The partners of Essex Partnership and their partnership

interests were as follows:

Percentage
Partner Partnership Interest

MHM 47.500
IRA 26.125
THC 21.375
Connolly 5.000

At trial, Connolly (1) did not know the identity of the

partners of Essex Partnership, (2) believed he was offered a 5-

percent partnership interest in Essex Partnership in exchange for

his promise to refer to Eulich any hotel management contracts

that GHM could not handle in the northeastern region of the

country, and (3) did not understand that a portion of GHM’s

management fees was remitted to Essex Partnership.

Essex Partnership’s stated purposes were (1) “To engage

generally in the consulting business and as a liaison

intermediary between owners and operators of hotel properties”,

and (2) “To enter into other partnership agreements * * *, to

114
At trial, Connolly (1) could not recall any details
about the GHM option agreement or whether he had received any
payments pursuant to the option agreement, (2) did not know
whether he had owned all of the shares of GHM, (3) could not
recall speaking to Eulich about startup financing of $10,000 for
GHM, and (4) could not recall whether the board of directors held
meetings at GHM or the membership of the board.
 -263-

become a member of a joint venture, or to participate in some

other form of syndication for investment; and to buy, sell,

lease, and deal in services, personal property, and real

property.”

In connection with the formation of Essex Partnership, GHM

and MHM entered into separate representation and marketing

agreements with Essex Partnership. GHM agreed to pay to Essex

Partnership 75 percent of its fees on GHM’s management contracts

on the Gateway Hilton and the Midland Hilton. MHM agreed to pay

to Essex Partnership 30 percent of its management fees from the

operation of the Madison Hotel and 43 percent of the fees from

the operation of the Allentown Hilton. In return, Essex

Partnership agreed to (1) “perform liaison functions” between

certain hotel owners and GHM and MHM in connection with

management contracts between such parties, (2) “perform liaison

functions” between the owners of any additional properties which

it was instrumental in securing for management by GHM or MHM, (3)

“use its best efforts to maintain satisfactory relations” between

the property owners and GHM and MHM “and to maintain sufficient

personnel to properly perform such [management] functions”, and

(4) “use its best efforts to secure management contracts”

satisfactory to GHM and MHM.

Essex Partnership had no offices and no employees. Very

few, if any, capital contributions were made to Essex
 -264-

Partnership. The record reflects that personnel associated with

MHM in effect provided all the financial and accounting services

that GHM required to fulfill its hotel management contracts. For

the most part, Connolly simply continued to serve as the onsite

manager of the Gateway Hilton.

In late 1983, Prudential awarded to MHM the hotel management

contract for the Twin Sixties Hotel. Shortly thereafter, MHM and

Essex Partnership modified their representation and marketing

agreement to provide that MHM would pay 70 percent of its

management fees from the Madison Hotel and 57 percent of its

management fees from the Allentown Hilton and the newly acquired

Twin Sixties Hotel management contract. On January 1, 1986,

Connolly executed a new representation and marketing agreement on

behalf of GHM which provided that GHM would pay to Essex

Partnership 40 percent of the fees earned on the Gateway Hilton

and Midland Hilton management contracts.

Over time, the total fees that MHM paid to Essex Partnership

generally equaled the total fees that GHM paid to the

partnership, and the total fees MHM paid to the partnership

roughly approximated MHM’s distributive share of partnership

income as a 47.5-percent partner in Essex Partnership. However,

as indicated previously, MHM was not paid directly for the

substantial services its employees rendered to GHM. Rather, as a

partner in Essex Partnership, MHM received 47.5 percent of the
 -265-

partnership’s income. Although IRA and THC, as partners, also

received a combined 47.5 percent of the income of Essex

Partnership, IRA and THC, in contrast to MHM, provided no

services to GHM.

Eulich and MHM’s top management essentially viewed Essex

Partnership as a marketing and sales device whereby MHM

eventually might obtain more management contracts for large

hotels. In addition, MHM needed to increase its level of

experience and expertise in managing and operating large hotels.

Because of the substantial services that MHM was providing GHM,

Eulich considered the Gateway Hilton and Midland Hilton

management contracts to be part of MHM’s management business.

Connolly could not explain the benefits that GHM would

receive under the GHM/Essex representation and marketing

agreement; he did not expect anyone at Essex Partnership to

perform liaison functions between himself and Prudential. From

MHM’s standpoint, Formby did not know what liaison functions

Essex Partnership was expected to perform for GHM, and he

believed that no such activities occurred. James, MHM’s

president, could not identify a specific person or entity who

would have acted as a liaison between the owners and operators of

the hotel properties in question. James did not know that IRA

and THC were partners in Essex Partnership until he was shown the

partnership agreement at trial. Eulich had never seen the Essex
 -266-

Partnership agreement or the representation and marketing

agreements between MHM and Essex Partnership. Eulich could not

explain how Essex Partnership would serve as “liaison

intermediary between the owners and operators of hotel

properties”. There were no officers or employees at Essex

Partnership who could have engaged in consulting or acted as

liaisons.

Between 1982 and 1988, GHM paid $1,334,601 and MHM paid

$1,563,412 to Essex Partnership. During 1982 through 1989,

Essex Partnership distributed $788,452 to IRA and $645,099 to

THC.

On December 31, 1984, IRA transferred its Essex Partnership

interest to Carlco, TMT, and BWK. Carlco and TMT each received

an 11.75-percent partnership interest in Essex, while BWK

received a 2.6125-percent partnership interest in Essex. Essex

Partnership apparently was not informed of the transfer and

continued to make partnership distributions to IRA.

The record reflects that Connolly was little more than a

pawn with regard to Essex Partnership. Connolly knew very little

about GHM or Essex Partnership, and we infer from his testimony

that he was happy simply to receive a substantial salary for

ostensibly managing both the Gateway Hilton and the Midland

Hilton. In fact, MHM provided the necessary management support

services for all of the hotels in question. Kanter, Ballard, and
 -267-

Lisle used Essex Partnership as a conduit to receive a portion of

the management fees paid to GHM on the Gateway Hilton and Midland

Hilton management contracts (through distributions to IRA), and

Kanter received a separate portion of those same management fees

(through distributions to THC). As discussed in the flow-of-

funds analysis below, the distributions that IRA received from

Essex Partnership were distributed to Carlco, TMT, and BWK.

Essex Partnership represented an effort by Kanter, Ballard, and

Lisle to assign to IRA and/or THC income that they earned.

E. Flow-of-Funds Analysis

The Court’s additional findings of fact regarding the flow

of funds from The Five to IRA and from IRA ultimately to Kanter,

Ballard, and Lisle are summarized in table 11. Table 11 shows

that with so-called capital contributions, loans that were never

repaid, and other payments to Kanter, Ballard, Lisle, and their

families, IRA transferred to Carlco and/or Lisle, TMT and/or

Ballard, and BWK and/or Kanter, in a roughly 45/45/10 percent

split, all of the payments from The Five (and nothing more). The

flow-of-funds analysis also demonstrates that Kanter, Ballard,

and Lisle had unrestricted use and enjoyment of the assets IRA

transferred to BWK, TMT, and Carlco, and they treated those

assets as their own.

The Court’s additional findings of fact regarding the flow

of funds from The Five to THC, and ultimately to Kanter and
 -268-

Lisle, are set forth supra pp. 207-213. Although the funds paid

by The Five to THC could not be traced directly to Kanter and

Lisle because of a lack of complete general ledgers for THC and

TACI for the years in question, we are satisfied that the

transfers of funds between THC, TACI, and Kanter documented in

the record demonstrate that Kanter used the funds from THC as his

own. We likewise conclude that Kanter arranged FPC Subventure

Partnership as a conduit to pass to Lisle at least a portion of

Lisle’s share of the fees that Schaffel paid to THC.

The following summary (subsections 1-4) highlights the more

important aspects of the flow of funds.

1. Payments to IRA: 1977 Through 1983

During the period 1977 through 1983, IRA (and Zeus) received

in the aggregate approximately $5 million in payments from The

Five. Although IRA reported these payments as income on its tax

returns, IRA paid very little in taxes.

In 1984, IRA began distributing some of its cash and

partnership interests to Carlco, TMT, and BWK in a 45/45/10

percent split. Specifically, during 1984, IRA transferred

approximately $4.2 million to Carlco, TMT, and BWK. The

distributions to Carlco and TMT represented a large portion of

Lisle’s and Ballard’s shares of the payments that IRA received

from The Five.
 -269-

2. Payments to IRA: 1984 Through 1989

After 1983, the structure through which the payments were

received from The Five changed. Although Hyatt Corp. continued

to make payments to KWJ Corp., IRA had liquidated the company and

distributed its assets to Carlco, TMT, and BWK, which formed KWJ

Partnership in early 1984. Thereafter, the Hyatt Corp. payments

were distributed by IRA to KWJ Partnership and reported on the

returns of Carlco, TMT, and BWK. Similarly, IRA had transferred

its interest in Essex Partnership to Carlco, TMT, and BWK.

Thereafter, IRA no longer reported the distributive income from

Essex Partnership on its returns. Instead, the distributive

share of income was reported on the returns of Carlco, TMT, and

BWK, respectively.

During the period 1984 through 1989, The Five made payments

to IRA (and Zeus) in the aggregate amount of $4.6 million. IRA

distributed (1) $1,103,721 that it received from Hyatt Corp. to

KWJ Partnership (and to Carlco, TMT, and BWK), and (2) $623,865

that it received from Essex Partnership to Carlco, TMT, and BWK.

IRA also transferred to Carlco, TMT, and BWK $2,287,191 in

installment payments that it received from PMS during 1984 to

1989.

Although there is no direct evidence that Zeus transferred

to IRA the approximately $232,000 in payments that it received

from Frey during 1984 and 1985, that amount nearly equals the
 -270-

approximately $250,000 that IRA lent to KWJ Partnership during

1985 to 1989 (which was used to make consulting payments to

Ballard’s and Lisle’s adult children, discussed below).

By the end of 1989, IRA’s records reflected that it had

transferred capital contributions and paid-in capital to Carlco,

TMT, and BWK as follows:

Carlco TMT BWK

$2,938,173 $2,938,267 $652,250

3. IRA Loans to Kanter, Ballard, and Lisle

a. IRA Loans to Ballard and Ballard’s Trusts

During the period 1974 to 1988, IRA, IFI, and HELO made

loans to three of Ballard’s grantor trusts (CMB Cinema Trust, CMB

Cinema Trust II, and Summit Trust) as well as separate loans to

Ballard individually. As of December 1987, IFI held receivables

or notes due from Ballard and his grantor trusts totaling

approximately $380,000.

b. IRA Loans to Lisle and Lisle’s Trusts

During the period 1974 to 1990, IRA, IFI, HELO, TACI, and

BWK made loans to three of Lisle’s grantor trusts (RWL Cinema

Trust, RWL Cinema Trust II, and Basking Ridge Trust) as well as

separate loans to Lisle individually. As of December 1987, IFI

held receivables or notes due from Lisle and his grantor trusts

totaling approximately $202,000.
 -271-

c. Sale of Grantor Trust Notes for $1

In December 1987, IRA held a receivable of $507,648 due from

IFI. IRA transferred the receivable back to IFI in exchange for

all of IFI’s assets, which included receivables due from

Ballard’s and Lisle’s grantor trusts as well as receivables due

from Ballard ($196,648) and Lisle ($28,284), respectively. IRA

then sold certain of the receivables due from Ballard’s and

Lisle’s grantor trusts (with a face value of approximately

$384,000) for $1 each to MAF, Inc. Morrison, MAF’s president,

admitted that MAF engaged in the transactions merely as an

accommodation to Kanter. In addition, after writing down the

value of the receivables due from Ballard and Lisle to $84,889

and $12,185, respectively, IRA treated these receivables as bad

debts for which it claimed deductions on its 1987 tax return.

After the IRS began its examination, Kanter contacted

Ballard and Lisle to discuss repayment of their debts. These

discussions were merely postexamination window dressing.

d. IRA Loans to Kanter

At the end of 1989, IRA’s records reflected loans to Kanter

totaling $600,000. There is no evidence that any principal or

interest was paid on these loans.
 -272-

e. Additional Loans to Lisle’s Grantor Trust

Between 1988 and 1990, IRA and Kanter made additional loans

to Lisle’s RWL Cinema Trust. These additional loans suggest that

either the earlier loans to RWL Cinema Trust were not worthless

when IRA wrote them off or the transfers were never valid loans

in the first place.

f. Consulting Payments to Ballard’s and Lisle’s
Adult Children

From 1984 to 1989, IRA made loans to KWJ Partnership

totaling $249,000. KWJ Partnership was formed by Carlco (45

percent), TMT (45 percent), and BWK (10 percent), which were

managed by Lisle, Ballard, and Kanter, respectively. As of July

30, 1990 (the date KWJ Partnership filed its tax return for

1989), these loans had not been repaid.

During much of the period 1982 to 1989, KWJ Corp. and KWJ

Partnership paid $1,000 per month to Ballard’s and Lisle’s adult

children and deducted the payments (which totaled $313,000) as

consulting fees. As the managers of Carlco and TMT, Lisle and

Ballard were aware of and acquiesced in these payments. Although

it appears that some of the children contacted Kanter at various

times with recommendations and suggestions for investments, the

record reflects that for many of the years in question they did

little or nothing to earn the payments. In fact, in letters to

the children terminating the payments in February 1990, Kanter

stated that “no services appear to have been performed for a
 -273-

number of years”, and Kanter explained that the payments had

continued because IRA’s president, Freeman, “paid no attention to

the activities of * * * [IRA] and its affiliates, and those who

were simply administering tasks on behalf of * * * [IRA]

routinely continued to make payments to you”. These payments

represented Ballard’s and Lisle’s shares of some of the payments

remitted to IRA by The Five that Ballard and Lisle attempted to

assign to their children.

4. Payments to THC: 1981 to 1989

During the period 1981 to 1989, Schaffel, Frey, and Essex

Partnership paid approximately $4 million to THC. The payments

from Frey ($500,770) and Essex Partnership ($645,099) represented

moneys that Kanter earned using his influence to bring deep-

pocket investors to Frey’s condominium conversion projects (and

his personal investment (through Zion) in those deals) and

arranging hotel management contracts for MHM. Kanter improperly

attempted to assign his earnings on these transactions to THC.

On the other hand, the approximately $2.8 million that

Schaffel paid to THC between 1984 and 1986 (ostensibly as

Kanter’s share of the fees that Schaffel earned arranging

Travelers financing for Walters’s development projects)

represented income earned by both Kanter and Lisle. Kanter and

Lisle improperly attempted to assign this income to THC. As
 -274-

discussed below, Kanter passed at least a portion of Lisle’s

share of this income to Lisle through FPC Subventure Partnership.

a. FPC Subventure Partnership

Kanter, purportedly as a nominee, acquired 8-percent limited

partnership interests in both Four Ponds Partnership and One

River Partnership--two partnerships organized by Schaffel and

Torcivia for real estate development projects. A “memorandum to

file”, dated April 14, 1982, stated (1) on January 1, 1981,

Kanter (as nominee) transferred his 8-percent limited partnership

interest in Four Ponds Partnership to Lisle (90 percent) and the

Everglades Trusts (10 percent); (2) Lisle issued a promissory

note to Kanter for $2,880; (3) Lisle and the Everglades Trusts

formed FPC Subventure Partnership; (4) on April 5, 1982, Four

Ponds Partnership made a $400,000 cash distribution to Kanter;

and (5) Kanter transferred the Four Ponds distribution to FPC

Subventure Partnership, which distributed $355,500 to Lisle and

$39,500 to the Everglades Trusts, leaving $5,000 in FPC

Subventure Partnership’s account.115

Contrary to Kanter’s testimony, Schaffel and Torcivia were

not aware that Lisle was a partner in FPC Subventure Partnership.

115
Contrary to the “memorandum to file”, FPC Subventure’s
tax return for 1982 and a Schedule K-1 issued to Lisle indicate
the partnership made a cash distribution of $427,600 and Lisle
received $384,840 (or 90 percent) of that amount.
 -275-

In 1982, Kanter also transferred his 8-percent limited

partnership interest in One River Partnership to FPC Subventure

Partnership in exchange for a $2,000 promissory note.

During the years at issue, Kanter (who held an interest in

FPC Subventure through grantor trusts) and Lisle reported

distributive shares of FPC Subventure’s partnership items of

income, loss, deduction, and credit on their individual tax

returns. However, Four Ponds Partnership and One River

Partnership (1) reported net losses in 1981 to 1984 and 1987 to

1989 totaling $1,067,131, and (2) made cash distributions to its

partners in 1981 to 1984 and 1987 to 1989 totaling $731,080.

Approximately 7 percent of Four Ponds’ and One Rivers’

partnership losses, described above, flowed through to Lisle

through FPC Subventure Partnership.

In addition to these favorable tax effects, during the

period 1981 to 1989 Lisle received at least $682,520 in cash

distributions from FPC Subventure Partnership.116 Consequently,

FPC Subventure Partnership served for Lisle the dual purposes of

(1) a tax shelter, and (2) a source of substantial cash

distributions. Kanter structured FPC Subventure Partnership as a

116
FPC Subventure Partnership’s tax returns for 1985 and
1986 apparently were not made part of the record.
 -276-

conduit to transfer to Lisle at least a portion of his share of

payments remitted to THC.117

b. THC Transfers to Kanter

During the period 1983 to 1984, THC transferred substantial

sums of money into TACI accounts, and TACI transferred smaller

amounts back to THC. During this same period, Kanter received

substantial loans from TACI, and many of these loans, totaling

approximately $1.3 million, had not been repaid when TACI filed

for bankruptcy in early 1988. There is no evidence that Kanter

ever paid any principal or interest on these loans.118 Kanter

arranged for transfers from THC to TACI and from TACI to himself

with no intention of repaying TACI or THC.

F. Kanter-Related Entities Were Shams

1. IRA and THC

IRA, THC, and their subsidiaries served no legitimate

business purpose with regard to the transactions at issue in

these cases. The entities did not have employees and generally

only used the services of bookkeepers and administrators to

record transactions, receive and disburse funds, and handle

117
As previously noted, an earlier ruling in these cases
bars an additional allocation of income from the Travelers
transactions to Lisle. Because we are convinced that Lisle
received at least $682,250 from the Travelers transactions, we
shall take this factor into account and reduce the allocation to
Kanter by a like amount.
118
Gallenberger believed the TACI bank records that would
have clarified many of the questions surrounding Kanter’s loans
were last in Kanter’s possession.
 -277-

banking matters. The bookkeepers and administrators simply

followed Kanter’s instructions (which sometimes were conveyed

through Freeman, Weisgal, Meyers, and/or Gallenberger).

IRA’s officers and directors, including Freeman and Weisgal,

did not manage any business or provide any meaningful services to

The Five. Kanter disclosed that for several years Freeman had

been distracted by his own legal woes and did not manage IRA.

Weisgal recalled very little regarding any matters concerning

IRA’s operations and was not aware of anyone at IRA who provided

services to The Five.

Schaffel, Frey, Schnitzer, and Eulich uniformly testified

that they were looking to Kanter, and Kanter alone, to use his

influence with his wealthy and well-connected clients and

business contacts in an effort to generate additional business

opportunities for them. Kanter’s statements in his dealings and

negotiations with The Five are equally revealing that Kanter

would be providing the services and expected to be compensated

for those services. In the end, The Five entered into contracts

with and made payments to IRA, THC, and their subsidiaries only

because Kanter directed them to do so.

There is no evidence of any contract between IRA and Kanter,

nor is there any evidence that IRA controlled Kanter’s activities

in any way. To the contrary, Kanter orchestrated all business

matters concerning IRA or THC and their subsidiaries, and
 -278-

Kanter’s instructions were carried out by administrators and

bookkeepers including Freeman, Weisgal, Meyers, and Gallenberger.

There is no evidence that anyone at IRA or THC provided any

services to The Five. Kanter directed The Five to execute

agreements with and make their payments to IRA, THC, and their

subsidiaries in an effort to conceal that Kanter, Ballard, and

Lisle earned the payments remitted by The Five. IRA, THC, and

their subsidiaries were Kanter’s alter egos. Kanter, Ballard,

and Lisle improperly attempted to assign their income to IRA,

THC, and their subsidiaries.

2. Carlco, TMT, and BWK

a. Diversification and Deconsolidation

Kanter testified that (1) IRA always held a controlling

interest in Carlco, TMT, and BWK; (2) IRA transferred a

substantial portion of its cash and other property to Carlco,

TMT, and BWK beginning in 1984 as a “free cashflow” asset

allocation; (3) the allocation would allow for diversification of

IRA’s investments in that Carlco (with Lisle as manager) was to

invest primarily in municipal bonds), TMT (with Ballard as

manager) was to invest primarily in real estate, and BWK (with

Kanter as manager) was to make assorted investments; and (4)

Carlco and TMT were removed from IRA’s consolidated group of

corporations for tax reporting purposes (by issuing shares of

preferred stock to trusts for the benefit of Ballard’s and
 -279-

Lisle’s families) to ensure that (a) Carlco’s investments in

municipal bonds would not imperil IRA’s interest deductions, and

(b) no one at IRA (such as Freeman) would be able to second-guess

Ballard’s and Lisle’s investment decisions. None of these

assertions withstands serious scrutiny.

The record shows that (1) IRA acquired 1,000 shares of

common stock of Carlco, of TMT, and of BWK in December 1983, and

(2) Carlco preferred stock was issued to Christie Trust (Lisle’s

family trust), TMT preferred stock was issued to the Orient Trust

(Ballard’s family trust), and BWK preferred stock was issued to

the BK Children’s Trust (one of the Bea Ritch Trusts). The

record, however, is devoid of stock ledgers or related

information for these corporations after early 1984. Respondent

requested a comprehensive set of corporate records for Carlco,

TMT, and BWK; however, petitioners failed to produce such records

for the period after 1984. Although the paper record (stock

certificates) suggests that IRA owned a controlling interest in

Carlco, TMT, and BWK, the manner in which Kanter, Ballard, and

Lisle handled the assets that IRA transferred to those entities

(discussed supra pp. 178-194) indicates that, in substance, Lisle

owned Carlco, Ballard owned TMT, and Kanter owned BWK.

In 1984, Kanter directed IRA to transfer a substantial

portion of its cash on hand to Carlco, TMT, and BWK in a 45/45/10

percent split. IRA also transferred to Carlco, TMT, and BWK its
 -280-

partnership interest in Essex Partnership and its interest in KWJ

Corp. (both of which provided a steady stream of cash payments

and distributions), and IRA distributed to Carlco, TMT, and BWK

the annual installment payments that it received from PMS. These

distributions did not, however, represent an allocation of IRA’s

“free cash-flow” as Kanter alleged. IRA was transferring to

Carlco, TMT, and BWK shares of the payments derived (and to be

derived) from transactions with The Five.

Two facts demonstrate that Kanter’s explanation regarding

the distributions to Carlco, TMT, and BWK are not to be believed.

First, we note that the only asset transferred to Carlco, TMT,

and BWK with no apparent connection to The Five was a portion of

IRA’s interest in Sherwood/Forest Activities Partnership. By our

reckoning, this partnership did not provide any cashflow at all

and merely served as a source of deductions to shelter from

taxation a portion of Carlco’s, TMT’s, and BWK’s income for 1984

to 1987. Kanter’s explanation is also belied by the fact that

IRA held large of amounts of cash during the period 1984 to 1989

(particularly 1987) that it invested in CDs rather than

distribute to Carlco, TMT, and BWK. Thus, although Kanter

recommended that Carlco, TMT, and BWK should receive funds from

IRA in a 45/45/10 percent split of IRA’s free cashflow, Kanter’s

recommendation was instead part of a preexisting agreement among

Kanter, Ballard, and Lisle to share payments from The Five.
 -281-

There likewise is no support for Kanter’s assertion the

allocations to Carlco, TMT, and BWK would allow for

diversification of IRA’s investments.119 While Lisle invested

Carlco’s assets primarily in municipal bonds, the record reflects

that Ballard also invested up to 30 percent of TMT’s assets in

bonds, including municipal bonds. In addition, as of 1989,

another 20 percent of TMT’s assets was allocated to cash and

notes receivable (many of which were due from Ballard). Under

the circumstances, Kanter’s purported asset allocation achieved

very little in the way of diversification of investments.

Finally, Kanter’s explanation for the removal of Carlco,

TMT, and BWK from IRA’s consolidated group of corporations for

tax reporting purposes is implausible. First, even if it were

logical to remove Carlco from IRA’s consolidated group to protect

IRA’s interest deductions, this explanation does not clarify why

TMT and BWK (which were to invest primarily in real estate and

other miscellaneous investments, respectively) were likewise

removed from the consolidated group. There was no indication

that TMT’s and BWK’s planned investments would imperil IRA’s tax

deductions. Moreover, if Carlco, TMT, and BWK had truly remained

subsidiaries of IRA as Kanter contended, their removal from IRA’s

consolidated group for tax-reporting purposes would have done

119
Kanter did not manage the funds in BWK. As Kanter
testified: “BWK didn’t work out that way because I just didn’t
have the time to pay attention to it.” Kanter, Transcr. at 3701.
 -282-

nothing to shield Ballard and Lisle from oversight or second-

guessing by IRA’s officers.

In sum, IRA’s transfers to Carlco, TMT, and BWK represented

Lisle’s, Ballard’s, and Kanter’s shares of the payments derived

(and to be derived) from transactions with The Five. Further,

Carlco, TMT, and BWK were removed from IRA’s consolidated group

to reflect the reality that those corporations were owned and

controlled by Lisle, Ballard, and Kanter, respectively, and they

would each be responsible for their own taxes going forward.

b. Use and Enjoyment of Carlco’s, TMT’s, and BWK’s Assets

We do not credit Kanter’s explanations for the transfers to

Carlco, TMT, and BWK, and for the removal of those entities from

IRA’s consolidated group. The record shows that Lisle, Ballard,

and Kanter had unrestricted use and enjoyment of Carlco’s, TMT’s,

and BWK’s assets, respectively.

(i). Carlco

In April 1985, Lisle wrote a check for $3,000 against funds

in the Connecticut National Bank account to repay a loan that

TACI made to RWL Cinema Trust (one of Lisle’s grantor trusts).

The memo section of this check stated: “Payment on Loan”. In

short, Lisle used Carlco’s funds as his own to pay a debt of his

grantor trust.

In addition, Carlco owned a 45-percent partnership interest

in KWJ Partnership. IRA made substantial loans to KWJ
 -283-

Partnership which in turn KWJ Partnership used to make so-called

consulting payments to Ballard’s and Lisle’s adult children

during the period 1983 to 1989. Lisle was aware of and

acquiesced in these payments, and he was aware that the children

were not providing any meaningful services in exchange for the

payments.

We conclude Lisle owned Carlco and all of its assets, and

Lisle used Carlco as a conduit for receiving his share of the

payments from The Five.

(ii). TMT

During 1984, TMT purportedly made loans to Ballard,

Seabright Trust, and Seabright Corp.120 By 1989, TMT’s

outstanding loans to Seabright Trust and Seabright Corp. totaled

$135,155 and $41,520, respectively. The record does not include

any promissory notes issued in connection with the loans to

Seabright Trust or Seabright Corp. There is no evidence that

either Seabright Trust or Seabright Corp. paid interest on the

loans from TMT. As of the time of trial, the loans had not been

repaid.

From 1984 through 1989, TMT lent $146,943 and $160,000 to

Claude and Mary Ballard, respectively. Although Ballard

120
Ballard believed Seabright Trust was an entity used to
make tax-sheltered investments. Seabright Corp., which owned a
farm in Arkansas, was owned by the Mary Family Trust, a trust for
the benefit of Ballard’s wife and daughters.
 -284-

purportedly arranged in December 1986 to repay the $160,000 loan

to Mary Ballard with Macy’s preferred stock, TMT’s accounting

records do not indicate that the $160,000 loan was ever repaid.

In 1986, TMT paid $100,000 for an asset described in TMT’s

general ledger as “LAND ST. FRANCIS COUNTY [ARKANSAS] 414.28

ACRE”.121 This asset was subsequently removed from TMT’s general

ledger, and adjusting journal entries indicated that an asset

identified as “Fairfield Planting Company” was transferred to

Ballard, and Ballard’s loans from TMT were increased by $100,000.

When Gallenberger was questioned about this transaction, she

could not recall the details and suggested Ballard should be

questioned on the matter. Ballard testified that (1) the

transaction involved his acquisition of stock in Fairfield

Planting Co., an S corporation involved in farm operations in

Arkansas; (2) he owed TMT approximately $200,000 on the

transaction; (3) TMT continued to receive “interest” on the deal;

(4) he owned two-sevenths of Fairfield; (5) the initial Fairfield

investment was $1,350,000, and the investment had increased in

value to approximately $2,350,000; and (6) the Fairfield

transaction was a good deal for TMT and a bad deal for him.

121
TMT’s general ledger also reflected a separate
transaction involving what appears to be another property in St.
Francis County identified as land ($424,800), along with a
building ($25,200) and building improvements ($10,925).
 -285-

The record also includes a promissory note that Ballard

purportedly executed on January 20, 1987, which provided (1)

Ballard agreed to pay to TMT, on demand, the principal sum of

$100,000, and (2) the note would not bear interest but TMT was

entitled to receive 90 percent of the “dividends” paid to Ballard

by Fairfield. At the same time, Ballard’s wife, Mary Ballard,

acting as TMT’s president, and Ballard signed an agreement which

stated that (1) Ballard was executing a note to TMT and was

pledging 1,000 shares of Fairfield common stock as security for

the note, and (2) TMT, as part of the transaction, agreed to

advance in the future “any deficits incurred by * * * Ballard in

the operations of Fairfield * * * and is to receive 90% of the

dividends paid by Fairfield”. Mary Ballard, acting in her

individual capacity, and Ballard also signed an assignment which

stated that “for the purpose of securing the payment of all

indebtedness now owing, or which may at any time hereafter be

owing” by Ballard to TMT, the Ballards assigned to TMT 1,000

shares of Fairfield common stock.

In 1987, TMT apparently paid an additional $20,344 to

Fairfield, and this amount was treated as an additional loan to

Ballard.

The Ballards reported Fairfield items of income and loss on

their 1987, 1988, and 1989 tax returns.
 -286-

Ballard’s explanation for this transaction and petitioners’

treatment of the matter in their reply brief are contradictory.

It is not clear that TMT ever owned shares in Fairfield Planting

Co. that it could transfer to Ballard. See Petitioners’ Reply

Brief at 625-626. In any event, Ballard’s testimony suggests the

asset he received, described by him as stock in Fairfield

Planting Co., was worth considerably more than the $100,000

charged to him as a loan. Finally, the terms of Ballard’s

promissory note associated with this transaction suggest self-

dealing and an effort to create an instrument for a debt that

would never be repaid. In the absence of any evidence in the

record that TMT ever received any payments (interest, dividends,

or otherwise) attributable to Ballard’s promissory note, we

conclude that the promissory note was a sham.

TMT’s records show that in 1988, TMT purportedly purchased

$15,000 of stock in Ficom International, Inc., a corporation

organized by Ballard’s daughter, Melinda Ballard. The entry

reflecting the investment includes a handwritten notation “W/O in

1989.” In 1989, TMT recorded in its trial balance ledger a

$15,000 long-term capital loss on its investment in Ficom.

Adjusting journal entry No. 6 explained the writeoff as follows:

“To w/o worthless stock of Ficom as per note on 1988 TB [trial

balance]”. TMT claimed this loss as a deduction on its 1989 tax

return.
 -287-

In addition, TMT owned a 45-percent partnership interest in

KWJ Partnership. IRA made substantial loans to KWJ Partnership

which in turn KWJ Partnership used to make so-called consulting

payments to Ballard’s and Lisle’s adult children during the

period 1983 to 1989. Ballard was aware of and acquiesced in

these payments, and he was aware that the children were not

providing any meaningful services in exchange for the payments.

Ballard made loans to himself and his family members from

TMT’s assets with no intention of repaying those loans, and he

transferred property acquired by TMT to himself in exchange for

an illusory promissory note. We conclude Ballard owned TMT and

all of its assets, and Ballard used TMT as a conduit for

receiving his share of the payments from The Five.

(iii). BWK

During 1984 through 1989, Kanter and his son, Joshua Kanter,

received salaries from BWK totaling $210,000 and $26,000,

respectively. However, Kanter admitted that he never had the

time to manage BWK’s investments.

In April 1985, BWK lent $400,000 to Kanter. By the end of

1987, the $400,000 loan had not been repaid. In 1988 and 1989,

the $400,000 loan was reduced by approximately $30,000 each year.

Adjusting journal entries treated these loan reductions as salary

that otherwise would have been paid to Kanter. There is no

evidence that Kanter paid any interest on the $400,000 loan.
 -288-

During the period 1987 to 1989, BWK lent a total of $236,000

to PSAC to support its operations. At the time the record in

these cases was closed, PSAC had not repaid the loans from BWK.

We conclude Kanter owned BWK and all of its assets, and

Kanter used BWK as a conduit for receiving his share of the

payments from The Five.

G. Cracks in the Kanter Facade

We have adopted many of the general findings of fact

recommended in the STJ report. The findings so adopted, combined

with the Court’s additional findings of fact regarding (1) the

manner in which Kanter, Ballard, and Lisle carried out the

transactions with The Five, (2) the flow of the funds, and (3)

the use and enjoyment of the assets transferred to Carlco, TMT,

and BWK, constitute overwhelming objective evidence that Kanter,

Ballard, and Lisle participated in a complex, well-disguised

scheme to share kickback payments earned jointly by Kanter,

Ballard, and Lisle.

We briefly list the following items (subsections 1-7) as

further evidence that Kanter, Ballard, and Lisle earned the

payments that The Five remitted to various Kanter-related

entities.

1. The Hyatt Transaction

In March 1983, Weaver forwarded to Kanter the most recent

payment from Hyatt Corp. to KWJ Corp. Weaver’s letter requested
 -289-

that Kanter deposit the check “and issue appropriate checks to

the participants.” In using the word “participants”, Weaver was

referring to Kanter, Ballard, and Lisle.

Later, in August 1989, IRA issued checks for $22,618.80 each

to Ballard and Lisle. After the checks were issued to Ballard

and Lisle, IRA records reflected a transfer of $45,237 to KWJ

Partnership on August 8, 1989. Also on August 8 and 15, 1989,

IRA ledger entries reflected that the checks issued to Lisle and

Ballard, respectively, were void. Despite the fact that IRA’s

ledger entries stated that these checks were voided, Lisle’s 1989

return reflected that he actually cashed the check. Lisle

reported $22,619 on his return as income from the “KJW [sic]

Company.” The checks issued to Ballard and Lisle reflected that

Ballard and Lisle (as opposed to KWJ Partnership) earned shares

of all Hyatt Corp. payments to KWJ Corp.

2. Frey

An October 1983 letter from BJF, Inc., to Kanter remitted a

check made payable to Kanter. The letter stated that the check

represents “your 5% participation of our $300,000.00 incentive

fees received from Prudential for 50% of units closed at Calais,

Chatham and Valleybrook.” Although the check was later voided

and replaced with a check made payable to Zeus, the letter

reflected that it was Kanter (along with Ballard and Lisle), not

Zeus, who earned a share of Frey’s incentive fees.
 -290-

In addition, when BJF Partnership was formed in 1984, the

partnership agreement recited that among the items transferred to

the partnership by the partners were “Two Participation

Agreements with Burton J. Kanter regarding certain condominium

conversions. These agreements have been terminated with respect

to new conversions.” The BJF Partnership agreement included

representation and warranty clauses under which Kanter stated

that (1) he did not need any consent, authorization, or approval

to contribute the participation agreements to the partnership,

and (2) the termination of the participation agreements was

valid, binding, and effective. This transaction is significant

because the participation agreements referred to were the

Frey/Zeus agreement and the Frey/THC agreement. Contrary to

Kanter’s assertion that he did not own or control IRA or Zeus,

this transaction suggests that Kanter exercised complete control

over those entities.

3. Schaffel

Although Kanter testified that Prudential business was not a

subject of discussion at his 1979 dinner meeting with Ballard,

Lisle, and Schaffel, Lisle believed that it was obvious Kanter

arranged the meeting to see whether Schaffel might be able to do

business with Prudential.

In addition, the 1984 dispute between Schaffel and Kanter

over whether Schaffel was required to continue making payments to
 -291-

IRA reveals that both Schaffel and Kanter understood that their

fee-sharing agreement was inextricably tied to Ballard and Lisle.

Schaffel hoped to restrict the fee-sharing agreement to

Prudential transactions only,122 whereas Kanter maintained the

agreement required Schaffel to share any fees arising from his

business dealings with Ballard and Lisle wherever they might be

employed.

4. Schnitzer/PMS

In February 1989, Kanter wrote to Ross and inquired whether

PMS would be interested in making an early, discounted final

payment under the IRA/PMS installment agreement. Kanter

mentioned in his letter that IRA had assigned its contract rights

under the IRA/PMS installment agreement and that any payment

should be remitted to PSAC, which served as the depository for

the assignee. There is no evidence in the record that IRA ever

assigned its rights under the IRA/PMS installment agreement to

another party. Kanter used the term “assignment” because he knew

the payments belonged to himself, Ballard, and Lisle, and he had

122
Schaffel explained that he stopped making payments to
Kanter/IRA in 1983 because “I said, ‘The deal is off. Bob
[Lisle] has moved and I am not going to, you know--the
relationship is over.’” Schaffel, Transcr. at 402. Schaffel
also testified: “I didn’t believe that [Kanter] was entitled to
that money because we had left the Investment Research agreement
because Bob [Lisle] had moved on to Travelers and Claude
[Ballard] had moved on to Goldman Sachs and I was no more dealing
with The Prudential.” Schaffel, Transcr. at 395.
 -292-

already instructed PSAC to transfer the final payment in

appropriate shares to Carlco, TMT, and BWK.

5. Loans to Ballard

TACI’s June 30, 1984, trial balance ledger reflected that

loans had been made to Ballard, Seabright Trust, and Seabright

Corp. Although there is no indication whether these loans

originated from TACI, IRA, or some other Kanter-related entity,

subsequent accounting entries resulted in the transfer of these

loans to TMT. The transfer of these loans to TMT was not a

random event--the treatment of these loans reflected that Ballard

owned TMT’s assets, and, therefore, his loans were charged to

TMT.

6. Ballard’s Disclosures to Goldman Sachs

In October 1988, Ballard submitted to Goldman Sachs a

disclosure statement concerning his outside business

affiliations. Ballard’s disclosure stated: “I am personally

involved in substantial farming operations individually as well

as in partnership form. Family trusts control two corporations

which are similarly involved.” Ballard’s reference to “Family

trusts” was to Orient Trust (which owned TMT) and Mary Family

Trust (which owned Seabright Corp.). In this regard, it is worth

noting that Ballard reported as income substantial director’s

fees from Seabright Corp. during 1987 to 1989. Ballard’s

explanation at trial that the family trusts he was referring to
 -293-

were the Bea Ritch Trusts, which owned IRA (and purportedly TMT),

strains credulity.

In August 1989, Ballard submitted to the Compliance

Department at Goldman Sachs a Request for Approval of Outside

Business Activities and/or Private Investments Form. In response

to a direction to provide a “Complete description of the

investment or business affiliation. What is it and who else is

involved in it as principals? Does it involve a public or

private company?”, Ballard answered, in part: “Farmland--Have

been buying and selling for years.” If Ballard was managing TMT

for IRA as he and Kanter contend, Ballard would have been

required to disclose to Goldman Sachs that TMT and/or IRA were

the principal owners of the farmland that Ballard was buying and

selling.

The record also shows that Ballard did disclose to Goldman

Sachs that he served as the director of an organization called

ICM Property Investors. His involvement in this organization was

through a “close friend” who controlled the organization.

Ballard never submitted such a form to Goldman Sachs with respect

to TMT because Ballard owned TMT.

7. Kanter’s Letters to the Ballard and Lisle Children

In early February 1990, after the IRS began examining

Ballard’s, Kanter’s, and Lisle’s tax returns for the years at

issue, Kanter sent letters to Ballard’s and Lisle’s children
 -294-

terminating their “consulting arrangement” and stating that

“fundamentally no services appear to have been performed for a

number of years”. Kanter’s letters went on to state that Freeman

was so preoccupied with his own legal woes during the latter half

of the 1980s that he was not managing IRA and the persons issuing

the checks were simply “administering tasks”.

Upon closer examination, Kanter’s letters to the children

are remarkable in that they demonstrate Kanter’s attempt to

rewrite history in the face of an expanding IRS examination. In

fact, Kanter’s letters were inconsistent with both the record in

these cases and earlier explanations Kanter offered for the

organization of Carlco, TMT, and BWK.

Recall that IRA liquidated KWJ Corp. in late 1983 and

transferred its rights under the Hyatt Corp./KWJ agreement to

Carlco, TMT, and BWK in a 45/45/10 percent split as part of an

alleged free cashflow asset allocation. Carlco, TMT, and BWK in

turn formed KWJ Partnership, which received both the Hyatt Corp.

payments and loans from IRA (which were used to fund the payments

to Ballard’s and Lisle’s children). Recall also Kanter’s

explanation that Carlco, TMT, and BWK were removed from IRA’s

consolidated group of corporations in 1984 in part to ensure

Ballard and Lisle could manage TMT’s and Carlco’s assets (which

included the cash distributions from KWJ Partnership and loans

from IRA) without interference from IRA’s officers. Consistent
 -295-

with this explanation, Ballard and Lisle, as TMT’s and Carlco’s

managers, were fully cognizant of the payments that KWJ

Partnership was making to their children. Kanter’s letters

contradict this scenario, are not credible, and represent an

11th-hour attempt by Kanter to recharacterize the payments to

Ballard’s and Lisle’s children as a clerical or administrative

error.

Kanter’s letters were also inconsistent with the record in

these cases to the extent Kanter suggested that no one was

managing IRA during the latter half of the 1980s. Although

Kanter’s letters rang true in the sense that Freeman was not

managing IRA (in fact, Freeman never managed IRA), the record in

these cases amply demonstrates that someone was in firm control

of IRA’s affairs. Recall, for example, that in 1987 IRA (1)

engaged in a complex transfer of notes with IFI and then sold 10

of those notes for $1 each to MAF, and (2) discounted and then

wrote off as bad debts notes due from Ballard and Lisle

individually. As had been the case all along, the person firmly

in charge of IRA’s affairs was Kanter.

H. Conclusion and Schedule of Income Adjustments

As previously discussed, we have weighed the recommended

findings of fact and credibility determinations set forth in the

STJ report against the entire record in these cases. On the

basis of our review, with particular emphasis on the additional
 -296-

findings of fact that we have culled from the record in an effort

to fully illuminate the transactions in dispute, we reject as

manifestly unreasonable the STJ report’s acceptance of Kanter’s

and Ballard’s testimony, and Lisle’s statement to IRS agents,

that they were not participants in a kickback scheme. There is

abundant and overwhelming objective evidence of record that the

payments from The Five constituted income earned by Kanter,

Ballard, and Lisle (and in some instances by Kanter alone) and

that income was delivered to Kanter, Ballard, and Lisle by way of

a circuitous and well-concealed route through various Kanter-

related entities. The objective evidence regarding Kanter’s,

Ballard’s, and Lisle’s general conduct and the flow of funds in

these cases wholly discredits petitioners’ testimony that they

were not involved in a kickback scheme. Consequently, we reject

petitioners’ testimony as inherently improbable and conclude,

contrary to the STJ report, that Kanter, Ballard, and Lisle

earned income in the form of payments from The Five during the

years at issue and failed to report that income on their tax

returns.

Kanter arranged to conceal Ballard’s and Lisle’s roles in

the scheme by funneling the payments from The Five to sham

entities including IRA, THC, Carlco, TMT, BWK, and FPC Subventure

Partnership. Those entities served no legitimate business
 -297-

purposes, and they were nothing more than the alter egos of their

masters.

The following schedule lists the total amounts of payments

from The Five to IRA during 1977 to 1989 and the portions of

those payments that constitute income properly attributable to

Kanter, Ballard, and Lisle:

Total payments
Year To IRA1 Kanter Ballard Lisle

1977 $54,848 -- -– --
1978 60,739 $6,074 $27,333 $27,333
1979 250,000 13,636 61,364 61,364
1980 1,025,436 56,899 455,310 455,310
1981 1,092,055 107,842 485,289 485,289
1982 1,606,837 159,321 716,940 716,940
1983 967,014 95,338 429,020 429,020
1984 784,524 77,089 346,899 346,899
1985 817,420 80,379 361,703 361,703
1986 673,421 65,979 296,903 296,903
1987 711,839 69,821 314,191 314,191
1988 676,603 66,297 298,335 298,335
1989 944,927 93,129 419,081 419,081
1
The Court is not persuaded that Ross’s testimony regarding
the manner in which Century valued PMS when it purchased the
company in 1974 provides a sound basis for determining the value
of PMS stock when IRA purchased PMS shares in 1977 or when IRA
sold those PMS shares in 1979. Consequently, we have accounted
for the Schnitzer/PMS installment payments to IRA during 1979 to
1989 (see table 7, supra, p. 131) by reducing the total principal
payment for each year by $13,636 to reflect the return of the
$150,000 that IRA paid for the PMS shares in 1977 (i.e.,
$150,000/11 years = $13,636 per year).

The following schedule lists the total amounts Schaffel,

Frey, and Eulich/Essex Partnership paid to THC during 1981 to
 -298-

1989 and the portions of those payments that constitute income

properly attributable to Kanter:123

Total payments
Year to THC Kanter

1981 $80,616 $80,616
1982 70,538 70,538
1983 80,325 80,325
1984 822,840 595,333
1985 1,514,882 1,287,375
1986 1,069,335 841,828
1987 132,323 132,323
1988 96,188 96,188
1989 42,322 42,322

Issue II. Whether Kanter and Ballard Are Liable for Additions to
Tax for Fraud

OPINION

Having determined the payments from The Five represented

income earned by Kanter, Ballard, and Lisle, we must review

respondent’s determinations that Kanter and Ballard are liable

for additions to tax for fraud.

In asserting that a taxpayer is liable for the addition to

tax for fraud, the Commissioner has the burden of proving, by

clear and convincing evidence, that some part of the underpayment

for each year at issue was due to fraud. Sec. 7454(a); Rule

142(b). Consequently, the Commissioner must establish (1) an

underpayment, and (2) that some part of the underpayment is due

123
Kanter’s total share of the $2,763,500 in payments that
Schaffel remitted to THC during 1984 to 1986 has been reduced to
$2,080,980 to account for the $682,520 that we conclude Kanter
transferred to Lisle (representing Lisle’s share of a portion of
the Schaffel payments) by way of FPC Subventure Partnership.
 -299-

to fraud. King’s Court Mobile Home Park, Inc. v. Commissioner,

98 T.C. 511, 515-516 (1992); Truesdell v. Commissioner, 89 T.C.

1280, 1301 (1987).

Fraud is an intentional wrongdoing by the taxpayer with the

specific purpose of evading a tax known or believed to be owing.

Stoltzfus v. United States, 398 F.2d 1002, 1004 (3d Cir. 1968);

McGee v. Commissioner, 61 T.C. 249, 256 (1973), affd. 519 F.2d

1121 (5th Cir. 1975). The Commissioner’s burden of proving fraud

is met if it is shown that the taxpayer intended to evade taxes

known to be owing by conduct intended to conceal, mislead, or

otherwise prevent the collection of taxes. Stoltzfus v. United

States, supra at 1004-1005; Rowlee v. Commissioner, 80 T.C. 1111,

1123 (1983).

The existence of fraud is a question of fact to be resolved

from the entire record. DiLeo v. Commissioner, 96 T.C. 858, 874

(1991), affd. 959 F.2d 16 (2d Cir. 1992); Gajewski v.

Commissioner, 67 T.C. 181, 199 (1976), affd. without published

opinion 578 F.2d 1383 (8th Cir. 1978). The taxpayer’s entire

course of conduct can be indicative of fraud. Stone v.

Commissioner, 56 T.C. 213, 224 (1971). Because fraud can rarely

be established by direct proof of the taxpayer’s intention, fraud

may be established by circumstantial evidence and reasonable

inferences drawn from the record. DiLeo v. Commissioner, supra

at 874-875; Rowlee v. Commissioner, supra at 1123. However, the
 -300-

mere suspicion of fraud is insufficient because fraud is not to

be inferred or presumed. Carter v. Campbell, 264 F.2d 930, 935

(5th Cir. 1959).

In Bradford v. Commissioner, 796 F.2d 303, 307 (9th Cir.

1986), affg. T.C. Memo. 1984-601, the U.S. Court of Appeals for

the Ninth Circuit set forth a nonexclusive list of circumstantial

factors that may give rise to a finding of fraudulent intent.

Such “badges of fraud” include: (1) Understatement of income;

(2) maintenance of inadequate records; (3) failure to file income

tax returns; (4) implausible or inconsistent explanations of

behavior; (5) concealment of assets; and (6) failure to cooperate

with tax authorities.

In addition, substantial understatements of income for

successive years are strong evidence of fraudulent intent.

Rogers v. Commissioner, 111 F.2d 987, 989 (6th Cir. 1940), affg.

38 B.T.A. 16 (1938); Conforte v. Commissioner, 74 T.C. 1160, 1201

(1980), affd. in part and revd. on another issue 692 F.2d 587

(9th Cir. 1982); Otsuki v. Commissioner, 53 T.C. 96, 107-108

(1969); see also Baumgardner v. Commissioner, 251 F.2d 311, 316

(9th Cir. 1957), affg. T.C. Memo. 1956-112.

A. Failure To Report Substantial Amounts of Income

Kanter and Ballard both filed tax returns during the years

at issue and were fully aware of their obligations to report all

of their income and pay Federal income taxes. However, Kanter
 -301-

and Ballard failed to report substantial amounts of income for

successive years that they earned in the form of payments from

The Five.

B. Concealment of the True Nature of the Income and the
Identity of the Earners of the Income

Kanter created a complex structure of corporations,

partnerships, and trusts (including, among others, IRA, THC,

Carlco, TMT, BWK, KWJ Corp., KWJ Partnership, Essex Partnership,

Zeus, Zion, IFI, HELO, TACI, and PSAC) to receive, distribute,

and conceal the income that Kanter, Ballard, and Lisle earned

during the years at issue. Payments from The Five that Kanter,

Ballard, and Lisle earned and secretly agreed to share were

remitted to IRA and THC or one of their subsidiaries. The

payments were commingled with funds from other entities in TACI’s

accounts and later PSAC’s accounts. Large amounts of money were

distributed to various entities and individuals, including

Kanter, Ballard, and Lisle, through IRA, THC, HELO, and IFI. The

distributions were disguised as loans and recorded as

receivables. Kanter’s use of the various sham entities, and

Ballard’s complicity in that scheme, made it difficult and

sometimes impossible to trace the flow of the money and are

substantial evidence of their intent to evade tax.

C. Use of Sham, Conduit, and Nominee Entities

Kanter used sham, conduit, and nominee entities to conceal

the income that he and Ballard earned from The Five. As
 -302-

discussed above, IRA and THC did not serve any legitimate

business purpose with regard to the transactions in dispute.

Rather than engage in substantial business activities, IRA and

THC served as nothing more than conduits and shams to collect and

distribute payments that represented income taxable to Kanter and

Ballard. Similarly, TMT and BWK were entities created to conceal

the true nature of the payments remitted by The Five to Kanter

and Ballard. Kanter and Ballard owned and controlled BWK and

TMT, respectively. These entities were the repositories of their

income. Ballard used IRA, and later TMT, as nominees to receive

and hold his income. Likewise, entities such as KWJ Partnership

and Essex Partnership were used as conduits solely to conceal the

nature of the income and disguise the transfer of funds to Kanter

and Ballard and members of their families.

D. Reporting Kanter’s and Ballard’s Income on IRA’s and
THC’s Tax Returns

Kanter and Ballard reported their income on IRA’s tax

returns. Kanter also reported some of his income on THC’s tax

returns. Income was reported on IRA’s and THC’s returns to

create the appearance that those entities earned the income,

rather than Kanter and Ballard. Moreover, those corporations

paid very little in taxes. Later, Kanter and Ballard reported

income that they earned on the Hyatt Corp. transaction and the

Eulich/Essex Partnership transaction on the returns of TMT and

BWK.
 -303-

E. Commingling of Kanter’s and Ballard’s Income With Funds
Belonging to Others

Kanter and Ballard commingled their income with funds

belonging to others. Kanter directed and oversaw the commingling

of the moneys. Commingling of the income in TACI’s and PSAC’s

accounts with other unrelated income was designed to conceal the

nature of the income and the identities of the true earners of

the income. Kanter plainly attempted to disguise the nature and

source of the income by channeling the moneys through conduit

entities in an array of transfers over a period of many years.

Obviously, Kanter and Ballard did not want Prudential and others

(particularly the IRS) to know about the payments and their

failure to report their income.

F. Phony Loans

Kanter transferred substantial amounts of money from IRA and

related entities to himself and Ballard (as well as other

entities such as KWJ Partnership) labeled as loans and recorded

as receivables in an effort to conceal distributions of the

income in question. Many of these purported loans were not

properly documented, and there was little evidence of any

meaningful payments of principal or interest. Kanter later

arranged sham sales of some of these receivables for $1, and in

other instances the loans were discounted and then written off as

bad debts. Still other IRA holdings were treated as worthless

securities. Similarly, Ballard transferred substantial amounts
 -304-

from TMT to himself, his wife, Mary Ballard, and his daughter,

Melinda Ballard, labeled as loans and stock investments. Most of

these purported loans were not properly documented, and there was

little evidence of any meaningful payments of principal or

interest. We also infer from notations in TMT’s books and

records that a so-called investment in Melinda Ballard’s company

was prearranged to be written off as a worthless security the

following year. Finally, Kanter received substantial transfers

from TACI, labeled as loans, that appear to amount to nothing

more than transfers of funds from THC to himself.

G. False and Misleading Documents

Kanter used false and misleading agreements with Schaffel

and Frey to create the appearance that Frey’s agreements were

with Zeus and THC as opposed to Kanter himself. Similarly, in

the Eulich/Essex Partnership transaction Kanter used false and

misleading representation and marketing agreements to create the

appearance that the partnership would provide services for GHM

and MHM when in fact MHM simply provided services for GHM.

H. Failure To Cooperate During the Examination Process

Kanter made it clear to IRS examination personnel from the

beginning that he did not intend to cooperate and he would frame

the issues for examination, not the IRS. We are also convinced

Kanter directed Gallenberger (an officer of TACI and PSAC) and

Weisgal (the trustee of the Bea Ritch Trusts) to withhold
 -305-

documents from the IRS, or to simply turn the documents over to

Kanter. TACI and PSAC had a standing policy of refusing to turn

documents over to anyone other than their owner.

Kanter’s campaign of obfuscation and delay was particularly

evident during summons enforcement proceedings. The District

Court, in two separate rulings, concluded Kanter failed to

cooperate, acted in bad faith, and allowed documents to be

destroyed even after the IRS summonses for those documents had

been issued. First, the District Court observed: (1) Weisgal

testified that, after receiving a summons to compel production of

documents, some summoned documents relating to the Kanters had

been turned over to TACI, and some documents were discarded as

part of an alleged 3-year record retention policy;124 and (2)

Gallenberger testified that she disposed of some documents

related to Kanter after receipt of the IRS summons. United

States v. Administration Co., 74 AFTR 2d 94-5252, 94-2 USTC par.

50,479 (N.D. Ill. 1994). In addition, the District Court went on

to conclude that Kanter acted in bad faith inasmuch as he first

promised to produce the documents sought from TACI, PSAC, THC,

and other Kanter-related entities and then abruptly asserted in

early February 1994 that the entities in question were third-

124
The alleged record retention policy was, at best,
applied inconsistently. In any event, the alleged policy
provided no excuse for destroying documents that were the subject
of an outstanding IRS summons.
 -306-

parties over whom he had no control. Id. at 94-5254, 94-2 USTC

par. 50,479, at 85,769.

Less than a month later, the same District Court judge held

Gallenberger in contempt for a continuing failure to comply fully

with the IRS summonses. United States v. Administration Co., 74

AFTR 2d 94-5256, 94-2 USTC par. 50,480 (N.D. Ill. 1994).

Gallenberger’s contempt citation was affirmed on appeal. See

United States v. Administrative Enters., 46 F.3d 670 (7th Cir.

1995).

We infer from all the facts and circumstances that Ballard

agreed with Kanter’s strategy of obfuscation and delay in a

deliberate effort to hinder respondent’s efforts in these cases.

I. Conclusion

In the light of all these factors, we conclude respondent

has demonstrated by clear and convincing evidence that Kanter and

Ballard filed false and fraudulent tax returns for each of years

at issue. Specifically, we sustain respondent’s determinations

that (1) Kanter’s underpayments for 1978 to 1984 and 1986 to

1989, attributable to payments from The Five, were due to fraud

with intent to evade tax, and (2) Ballard’s underpayments for

1978 to 1982, 1984, and 1987 to 1989, attributable to payments

from The Five, were due to fraud with intent to evade tax.
 -307-

Consequently, Kanter and Ballard are liable for additions to tax

for fraud as asserted in respondent’s amended pleadings.125

Consistent with the foregoing, we reject Kanter’s and

Ballard’s assertions that the period of limitations governing

assessment and collection has expired for some of the years at

issue. In short, the period of limitations remains open for each

of years at issue pursuant to section 6501(c)(1) which provides

that tax may be assessed at any time in the case of a false and

fraudulent tax return with the intent to evade tax.

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

FINDINGS OF FACT

At issue is whether certain entities that claimed to be

partners in Century Industries, Ltd. (Century Industries or the

partnership) should be disregarded as partners of the partnership

for Federal income tax purposes and whether 50 percent of the

partnership’s income for 1981, 1982, 1983, 1984, and 1986,

instead, constitutes income earned by Kanter for those years.

125
Inasmuch as respondent asserted various other additions
to tax against Kanter and Ballard strictly as alternatives to
respondent’s assertion of the fraud additions (which we sustained
above with regard to income Kanter and Ballard earned from The
Five), we need not consider the alternative additions to tax.
126
The remainder of the issues discussed in this report
pertain only to the Kanters. Hereinafter, references to
petitioners are to the Kanters.
 -308-

Century Industries was a partnership organized in 1979, and

its partners were the Bea Ritch Trusts, Solomon Weisgal

(individually and for his own account, rather than as trustee of

the Bea Ritch trusts), and Earl Chapman. The 25 Bea Ritch Trusts

(collectively), Weisgal, and Chapman each held one-third

interests in the partnership. The partnership’s objective was to

engage in highly leveraged investments in which the partners

would contribute relatively minimal amounts of their own capital.

The partnership was ultimately unsuccessful in such investments.

In early 1980, the partnership was reconstituted. Chapman

withdrew from the partnership, new partners were admitted, and

the partnership’s investment focus was changed. The

reconstituted partnership purportedly would engage in investments

in which its partners would be required to contribute larger

amounts of capital. The new partners included Kanter, four

family trusts for the benefit of Weisgal’s family members (James

Children’s Trust, Lawrence Children’s Trust, Lee Children’s

Trust, and Richard Children’s Trust), and Atlay Valley

Investments General Partnership (Atlay Partnership), another

investment partnership composed of irrevocable trusts for the

benefit of Mr. Weisgal’s family. During 1980 and 1981, the

partners in Century Industries, their capital interests, and

their initial capital contributions were as follows:
 -309-

Partner 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

comprised 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 Weisgal’s accounting firm offices. After 1981,

its partners did not make additional capital contributions until

sometime in 1986. During 1986 and 1987, its partners made the

following additional capital contributions:

1986 Capital 1987 Capital
Partner Contrib. Contrib.

Bea Ritch Trusts $29,900 490
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
 -310-

From 1981 through 1986, Century Industries received payments

that Kanter contends were “standby commitment fees” to compensate

Century Industries for considering various investment

proposals.127 From 1981 through 1986, Century Industries received

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 --

Distributors
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 17,500 7,000 18,000 13,000 11,000 12,000
Stockholder -- -- -- 3,000 -- --
TACI -- -- -- -- 4,500 --
THC -- -- 1,000 -- -- --
Waco Capital -- -- -- -- 1,000 --
Zion -- -- 4,000 -- -- --
35,500 20,000 33,000 93,000 30,000 62,000

Silite, Inc. (Silite), paid Century Industries periodic

retainer fees. Weisgal, Transcr. 4939-4946, 4962-4965; Exhs.

9235, 9240, 9241; Exh. 9243, at 1, 4; Exh. 9244, at 2, 3; Exh.

9245, at 1, 3. Kanter and Weisgal performed the analyses of

127
The recommended finding of fact in the STJ report, at
88, that Century Industries earned standby commitment fees is
manifestly unreasonable. As discussed in detail below, the
record shows Kanter and Weisgal earned the fees in question.
 -311-

investment opportunities for Silite. Weisgal, Transcr. at 4939-

4946; Kanter, Transcr. at 4962-4965.

On February 1, 1984, Century Industries sent an invoice to

Satcorp for $100,000 for “Consultation, analysis, &

recommendations regarding financial advice and structuring in

connection with investment placement opportunities”. Exh. 9243,

at 2. On September 12, 1984, Satcorp and Century Industries (by

Weisgal), executed a letter agreement which stated in pertinent

part:

This letter will briefly outline the relationship
between 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 taken into
account any impact on successful fund
raising.
 -312-

The specific current engagement will be
compensated as follows:

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.
2. Equity

a) Century will vest to an amount of shares
equivalent to 7.5% of the outstanding common stock
of Satcorp as computed on December 8, 1983 to be
issued ... (during 1984 and 1985). Whenever
possible Century will apply its fees to individual
offerings of finance, so as to spread the burden
to various projects.

b) It is to be understood that in the event of death
or permanent disability of either Burton Kanter or
Solomon Weisgal, at Satcorp’s 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.

Exh. 9246.
 -313-

On November 20, 1984, Weisgal sent an invoice on behalf of

Century Industries to City & Suburban Distributors, Inc. (C&S),

in the amount of $6,000, for special tax and consulting services

through October 31, 1984. Exh. 9244, at 8, 10. A letter

accompanying the invoice stated:

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. [Id.]

On December 24, 1984, Century Industries sent a second letter to

C&S describing the work Century Industries performed during May

to September 1984 as including overall financial planning,

consideration of leverage debt financing, consideration and

evaluation of debt financing coupled with additional equity,

review and identification of sources of bank financing,

conference with lenders, review identification of potential

equity sources, and various meetings and updates with Angelo and

John Geocaris. Exh. 9244, at 9.
 -314-

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

Beginning in about 1987, Century Industries made certain

investments that required significant 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.

Century Industries filed Forms 1065 (U.S. Partnership

Returns) for 1980 through 1986 which demonstrate that Century

Industries made only a relatively small number of investments and

incurred minimal expenses during that period. On these returns,

the partnership reported the following items of income and

expenses:
 -315-

1980 1981 1982 1983 1984 1985 1986

Income
Unspecified -- -- -- -- -- -- $62,000
Flankin Ltd. -- -- $3,026 $5,186 $5,198 $7,047 6,056
Real Est. Loan -- -- -- -- -- 2,107 897

Assn.
Dividends -- $2,526 -- -- -- -- --
Interest -- 7 -- -- -- -- --
Dividends & int. -- -- 3,314 2,812 6898 7113 4347
Form 4684 -- -- -- (4,100) -- -- --
Other income/fees $1,000 35000 20,000 33,000 93,000 33,000 --
Total income 1,000 37,533 26,340 36,898 105,096 46,267 73,300

Deductions
Bank charges -- $5 -- -- -- -- $613
Legal fees -- -- $625 -- -- $1,000 --
Admin. services -- -- 3,000 -- -- -- --
Advertising exp. -- -- 2,652 -- -- -- --
Guaranteed pmts. -- -- -- $4,000 $12,000 7,500 12,000
Bus. & tax con- -- -- -- -- 12,345 7,500 25,000

sulting serv.
Telephone -- -- -- -- 376 300 5
Copying -- -- -- -- 19 764 10
Messenger service -- -- -- -- 15 9 14
Travel -- -- -- -- 2,134 726 --
Printing -- -- -- -- 92 -- --
Air fare $30 -- -- -- 928 -- --
Miscellaneous -- -- -- -- 330 249 11
Office services -- -- -- -- -- -- --
Total Deducs. 970 37,528 20,063 32,898 76,857 28,219 35,647

The $62,000 “unspecified income” shown above for 1986 consisted

of fees.

In notices of deficiency issued to the Kanters for 1981 to

1984 and 1986, respondent determined that Century Industries

income for those years constituted Kanter’s income. On brief,

respondent asserted that for 1981 through 1984 and 1986, Kanter

is taxable on 50 percent of the ordinary income reported by
 -316-

Century Industries plus any guaranteed payments he received

during those years. Respondent’s Opening Brief at 796.

Respondent issued a notice of final partnership

administrative adjustment (FPAA) to Century Industries

reallocating some of the partnership’s 1986 income to Kanter. No

FPAA was issued to Century Industries for 1983 and 1984. In

effect, respondent disregarded all of the other partners in

Century Industries except Kanter and Weisgal.

OPINION

A. The Parties’ Arguments

Petitioners contend: (1) All of Century Industries’

partners during 1981 to 1984 and 1986 should be respected as

partners for tax purposes; (2) no additional partnership income

should be attributed to Kanter as his taxable income; and (3) the

Court lacks jurisdiction to review respondent’s determinations

for 1983, 1984, and 1986 in the context of these deficiency cases

because Century Industries was a partnership subject to the

unified partnership administrative and litigation provisions

found in subchapter C of chapter 63 of subtitle F of the Internal

Revenue Code enacted as part of the Tax Equity and Fiscal

Responsibility Tax Act of 1982 (TEFRA), Pub. L. 97-248, 96 Stat.

324.

Respondent asserts that, for tax purposes, Kanter and

Weisgal are the only two persons who should be recognized as
 -317-

partners in Century Industries and each should be treated as

owning a 50-percent interest. Respondent asserts that, until

1987, the other purported partners’ interests in Century

Industries were shams, as the ostensible partnership between them

and Kanter and Weisgal existed only to shift income Kanter and

Weisgal earned, i.e., the fees paid to Century Industries, to

their family trusts--the other purported partners.

Respondent further maintains the Court has subject matter

jurisdiction over the 1983, 1984, and 1986 adjustments to

Kanter’s taxable income from Century Industries because the only

persons to be recognized as Century Industries partners for tax

purposes are Kanter and Weisgal, and, therefore, the partnership

is a small partnership specifically excepted from the TEFRA

partnership provisions.

B. TEFRA Partnership Provisions

The TEFRA provisions generally are applicable to specified

partnerships and other entities filing partnership returns for

taxable years beginning after September 4, 1982. TEFRA sec.

407(a)(1), (3), 96 Stat. 670. The TEFRA provisions were designed

to provide unified administrative and judicial procedures for the

determination and review of partnership items. A “partnership

item” is defined to include, among other things, the

partnership’s aggregate and each partner’s share of items of

income, gain, loss, deduction, or credit of the partnership.
 -318-

Sec. 6231(a)(3); sec. 301.6231(a)(3)-(1)(a)(1)(i), Proced. &

Admin. Regs.

Section 6231(a)(1)(A) defines the term “partnership” and

identifies the partnerships that are subject to the TEFRA

partnership provisions. Section 6231(a)(1)(B), in general,

excludes “small partnerships” from the section 6231(a)(1)(A)

definition of “partnership”.128 A small partnership generally is

a partnership (1) that has 10 or fewer partners, (2) all of whose

partners are either estates or natural persons who are U.S.

citizens or resident aliens, and (3) where each partner’s share

of each partnership item is the same as the partner’s share of

every other partnership item. Sec. 6231(a)(1)(B)(i); sec.

301.6231(a)(1)-1T(a)(1) through (3), Temporary. Proced. & Admin.

Regs., 52 Fed. Reg. 6789 (Mar. 5, 1987). A determination of

whether a partnership qualifies as a small partnership is to be

made for each of the partnership’s taxable years. Sec.

301.6231(a)(1)-1T(a)(4), Temporary. Proced. & Admin. Regs., 52

Fed. Reg. 6789 (Mar. 5, 1987).

C. The STJ Report

Applying the test articulated in Commissioner v. Culbertson,

337 U.S. 733, 742 (1949), the STJ report, at 103-105, recommended

holding that each of the named partners of Century Industries

128
A small partnership may elect to have the TEFRA
partnership provisions apply. Sec. 6231(a)(1)(B)(ii). However,
the parties agree Century Industries made no such election for
1983 through 1986.
 -319-

formed a good faith intent to conduct an enterprise with a

business purpose. The STJ report implicitly accepted Kanter’s

testimony that Century Industries (as opposed to Kanter and

Weisgal) earned the commitment fees in exchange for the

partnership’s evaluating and considering whether it would invest

in various business opportunities presented to it.

D. Analysis

In Commissioner v. Culbertson, supra, the Supreme Court held

that to be treated as a partner in a partnership for Federal

income tax purposes, a person must have contributed either

capital or services to the partnership. Id. at 738-740.

However, in Culbertson, the Court declined to impose a rigid

standard for determining partner status and instead held the

governing test is “whether, considering all the facts * * * the

parties in good faith and acting with a business purpose intended

to join together in the present conduct of the enterprise.” Id.

at 742.

After Culbertson, Congress enacted statutory provisions to

address the recognition of partners in family partnerships in

which capital is a material income-producing factor.

Specifically, section 704(e)(1) provides, as to partnerships in

which capital is a material income-producing factor, that a

person owning a capital interest in such a partnership must be

recognized as a partner, whether that person’s capital interest
 -320-

was acquired by purchase or gift. However, if appropriate,

partnership income (otherwise allocable to the donee of a

partnership interest) can be reallocated to ensure that the donor

of a partnership interest receives reasonable compensation for

services the donor renders to the partnership. Sec. 704(e)(2);

sec. 1.704-1(e)(3), Income Tax Regs. For purposes of section

704(e)(1), the determination of whether capital is a material

income-producing factor must be made with reference to all of the

facts presented in the particular case.129

As discussed in greater detail below, we agree with

respondent that, other than Kanter and Weisgal, Century

Industries’ purported partners are not to be recognized as

partners during the period 1981 to 1986 because they did not

intend to conduct a business enterprise. The contrary

recommended holding in the STJ report was manifestly

unreasonable. Inasmuch as Kanter and Weisgal were the only

partners of Century Industries recognizable for Federal income

129
In general, capital is considered a material
income-producing factor if a substantial portion of the gross
income of the partnership’s business is attributable to the use
of capital. Further, capital will not usually be considered a
material income-producing factor where the income of the business
consists principally of fees, commissions, or compensation for
personal services performed by the partnership’s members or
employees. On the other hand, capital is ordinarily a material
income-producing factor if operation of the business requires
substantial inventories or substantial investment in plant,
machinery, or other equipment. Carriage Square, Inc. v.
Commissioner, 69 T.C. 119, 126-127 (1977); sec. 1.704-
1(e)(1)(iv), Income Tax Regs.
 -321-

tax purposes, and Century Industries did not file an election

under section 6231(a)(1)(B)(ii) to have the exception for small

partnerships not apply, it follows that Century Industries was a

small partnership, within the meaning of section 6231(a)(1)(B),

to which the TEFRA partnership procedures do not apply.

Consequently, we hold the Court has jurisdiction in these

deficiency cases to determine whether half of the payments to

Century Industries during 1983, 1984, and 1986 represent income

earned by Kanter.

The record shows that, other than Kanter and Weisgal,

Century Industries’ purported partners rendered no services and

contributed only insignificant amounts of capital to the

partnership during the years at issue. Moreover, capital was not

a material income-producing factor for Century Industries during

1981 to 1986. No funds of any significance were collected from

the alleged partners until 1986, and most of Century Industries’

income during the period 1981 to 1986 consisted of fees and

commissions. Although Kanter asserted that the partnership was

formed as an investment vehicle, the partnership did not make any

significant investments during the period 1981 to 1986. During

the same period, Kanter and Weisgal provided professional

services for Silite, Satcorp, C&S, and others and arranged for

the payments for those services to be remitted to Century

Industries. Thus, insofar as Century Industries is respected as
 -322-

a partnership for the years in question, the partnership was

limited to Kanter and Weisgal, and, therefore, Kanter is taxable

on a one-half distributive share of Century Industries’ income.

Petitioners aver that Century Industries earned the fees in

question as compensation for evaluating whether it would make

certain investments. There is no direct evidence to support this

assertion. To the contrary, the objective evidence of record

demonstrates that the fees paid to Century Industries represented

compensation to Kanter and Weisgal for services they provided to

the payors, and those services were unrelated to any potential

investment by Century Industries. For example, a September 12,

1984, letter from Century Industries to Satcorp stated (1) Kanter

and Weisgal would serve as so-called financial engineers for

Satcorp and Kanter and Weisgal would be principally involved in

planning and structuring transactions for financing for Satcorp,

its operating companies, and its future projects, and (2) Century

Industries would consider participating in the actual process of

obtaining financing, but it “will not be routinely responsible

for any such activities.” Similarly, letters from Weisgal to C&S

in late 1984 revealed that Century Industries billed C&S for

services provided by Kanter and Weisgal including financial

planning, consideration of leverage debt financing, consideration

and evaluation of debt financing coupled with additional equity,

review and identification of sources of bank financing,
 -323-

conference with lenders, review identification of potential

equity sources, and various meetings and updates with Angelo and

John Geocaris.

In sum, the record shows that Kanter and Weisgal were

billing C&S at some sort of hourly rate, the services provided to

Satcorp and C&S related to an evaluation of various forms and

sources of debt financing those companies might pursue, and there

was no mention in these letters that Century Industries was

considering investing its own funds in any of the enterprises.

Weighing the overwhelming objective evidence summarized

above against Kanter’s and Weisgal’s testimony, we conclude the

testimony was inherently implausible and not credible, and the

STJ report was manifestly unreasonable in accepting that

testimony in the light of the documentary record in these cases.

We hold that one-half of Century Industries income during 1981 to

1984 and 1986 is income taxable to Kanter for those years.
 -324-

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

Respondent determined that payments of $42,720, $19,247, and

$109,399 Hi-Chicago Trust made to THC during 1981, 1982, and

1983, respectively, constituted income earned by Kanter. The

parties filed with the Court a stipulation of settled issues in

which Kanter conceded the adjustment for the taxable year 1981.

The parties disagree whether the payments Hi-Chicago Trust made

to THC during 1982 and 1983 represent Kanter’s income.

FINDINGS OF FACT

Hi-Chicago Trust was established in 1972. The trust’s

beneficiaries included members of Hyman Federman’s family.

Federman is a friend of Kanter. Neither Kanter nor Kanter’s

family are or have been beneficiaries of the trust.

From Hi-Chicago Trust’s inception in 1972 through at least

1989, Kanter was trustee for the trust. The trust instrument

130
The STJ report recommended holding that respondent is
barred from making any determination concerning the taxable year
1983 on account of the expiration of the period of limitations
governing assessment and collection for that year. As previously
discussed, we determined that Kanter’s income tax returns for the
years at issue were fraudulent, and, therefore, the period of
limitations remains open pursuant to sec. 6501(c)(1).

The foregoing aside, the Court’s disposition of this issue
represents in large measure a wholesale adoption of the
recommended findings of fact and conclusions of law set forth in
the STJ report.
 -325-

grants to the trustee broad powers with respect to making

investments on the trust's behalf.

At the time of the trust’s creation, Kanter, Federman, and

the trust’s beneficiaries orally agreed Kanter or Kanter’s

designee generally would have: (1) The right to receive payment

of an amount equal to 10 percent of any gains the trust realized

upon the sale or disposition of a trust investment, and (2) an

option to obtain from the trust a 10-percent portion of any trust

investment property upon payment to the trust of 10 percent of

the trust’s cost for that investment property. In the event the

foregoing option was exercised, the trust would distribute

in-kind to Kanter or Kanter’s designee a 10-percent portion of

that property. These payment obligations and option rights were

to last as long as the trust remained in existence. Pursuant to

the above arrangement between Kanter, Federman, and the trust’s

beneficiaries, during 1980 through 1983, Hi-Chicago Trust paid

THCthe following amounts on or about the dates indicated:

Date Payment

12/16/80 $80,000
8/11/81 33,925
10/23/81 8,795
1
10/13/82 19,247
2/18/83 50,000
3/15/83 22,224
5/11/83 6,199
9/14/83 1,227
9/14/83 29,749
 -326-
1
The $12,711 amount listed in the STJ report is erroneous.
See Exh. 9123.

Hi-Chicago Trust, on its income tax returns for fiscal years

ending February 28, 1981, through February 28, 1984, claimed

deductions with respect to the above payments to THC. On the

trust’s return for fiscal year ending February 28, 1981, the

payment to THC was characterized as “fiduciary fees”. On the

trust’s return for the fiscal year ending February 28, 1982, the

payments to THC were characterized as “participation fees”. On

the trust’s returns for its fiscal years ending February 28,

1983, and February 28, 1984, the payments to THC were claimed,

respectively, as “commissions” and “commissions expenses”. The

trust claimed no deductions for fiduciary fees on its 1982, 1983,

and 1984 fiscal year returns. Kanter, as the trust’s trustee,

signed the trust’s 1981, 1982, 1983, and 1984 fiscal year

returns.

OPINION

A. The Assignment of Income Doctrine

In United States v. Basye, 410 U.S. at 450, the Supreme

Court reiterated the longstanding principle that income is taxed

to the person who earns it, stating: “The principle of Lucas v.

Earl [281 U.S. at 115], 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
 -327-

today as a cornerstone of our graduated income tax system.” A

more recent expression by the Supreme Court of the same principle

appears in Commissioner v. Banks, 543 U.S. 426 (2005).

B. The Parties’ Arguments

Petitioners contend the payments THC received from Hi-

Chicago Trust are not taxable to Kanter under the assignment of

income doctrine. Petitioners argue Kanter held a property

interest with respect to the trust and he transferred that

property interest to THC well before the years at issue.

Petitioners also deny the payments THC received from the trust

were compensation for Kanter’s personal services.

Respondent, on the other hand, contends that under the

assignment of income doctrine, the payments were taxable

compensation for Kanter’s personal services.

C. Analysis

Whether the payments to THC are income to Kanter turns on

whether the payments were compensation for Kanter’s personal

services. Kanter testified that, pursuant to the 1972

arrangement among himself, Federman, and the trust beneficiaries,

Kanter was granted a “carried interest” as to Hi-Chicago Trust’s

investment gains and investment properties. Kanter claimed this

“carried interest” arrangement was totally independent of his

serving as Hi-Chicago’s trustee and the payments to THC were not

compensatory. Kanter added that, at some point during the 1970s,
 -328-

he had transferred his “carried interest” in Hi-Chicago Trust to

THC.

Kanter’s testimony on this point is self-serving and

unconvincing. In effect, petitioners assert Federman and the

trust beneficiaries, in agreeing to the 1972 arrangement, made a

“gift” to Kanter. However, the Court does not believe Federman

and the trust beneficiaries were acting out of a “detached and

disinterested generosity” to Kanter. See Commissioner v.

Duberstein, 363 U.S. 278, 285-286 (1960). Undoubtedly Federman

and the trust beneficiaries were eager to have Kanter serve as

trustee and manage the trust’s investments inasmuch as Kanter had

extensive business contacts and he offered the promise of

lucrative returns on the trust’s investments. Such profitable

trust investments could greatly benefit the trust’s

beneficiaries. The “carried interest” provided a direct

financial incentive to Kanter, as trustee and manager, to seek

out and make profitable investments on behalf of Hi-Chicago

Trust.131

131
Petitioners offered no testimony from Federman or the
trust beneficiaries. Nor did petitioners present any evidence as
to whether a gift tax return was filed with respect to the
granting of the “carried interest” to Kanter in the early 1970s.
Petitioners’ failure to offer such evidence leads the Court to
conclude this evidence would have been harmful to petitioners’
case. See Wichita Terminal Elevator Co. v. Commissioner, 6 T.C.
1158, 1165 (1946), affd. 162 F.2d 513 (10th Cir. 1947).
 -329-

In addition, as respondent points out, the compensatory

nature of the arrangement is confirmed by the trust’s tax

treatment of the payments to THC. The 1981 payment the trust

made to THC was deducted as a trustee’s fee, and the 1982 payment

was specifically characterized on the trust’s return as a

“commission”. Indeed, Kanter, as trustee, signed all the trust’s

returns. Although Kanter, in his testimony, denied that the

trust’s payments were compensation to him, he did not describe

what, if any, specific services THC had performed in exchange for

the trust’s payments. Kanter also offered no evidence regarding

the terms and conditions of his purported assignment of the

“carried interest” to THC.

The Court concludes the payments from Hi-Chicago Trust to

THC represented compensation to Kanter for his personal services,

and, as such, those payments are includable in Kanter’s taxable

income for 1982 and 1983 under the assignment of income

doctrine.132

132
On brief, petitioners argue that, even if the
arrangement was compensatory, Kanter realized taxable income only
in 1972, at the time he received the “carried interest”, not in
1982. This argument was not timely raised and, in any event, is
not persuasive.
 -330-

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

FINDINGS OF FACT

A. The Bea Ritch Trusts

As noted earlier, the Bea Ritch Trusts consist of 25

separate trusts, established on or about January 1, 1969, for the

benefit of Kanter, Kanter’s family, and other relatives of

Kanter.134 Initially, Kanter was a beneficiary of each of the 25

trusts. Since about 1969, Weisgal has been the trustee for each

of the 25 trusts.

In the common trust instrument, dated January 1, 1969, that

established each of the 25 trusts, Bea Ritch (Kanter’s mother)

was identified as the trusts’ settlor. She purportedly funded

each trust with a corpus of $100. There is no evidence Bea Ritch

actually contributed $100 each to the trusts or that she made any

subsequent contributions to the trusts. The common trust

instrument granted the trustee (who has always been Weisgal) an

extremely broad sprinkle power. In addition, Kanter was given a

133
As discussed below, although this issue concerns
Kanter’s tax liability for 1986 and 1987, Kanter did not appeal
the decision entered in his case at docket No. 24002-91 on Sept.
24, 2001, concerning his liability for the taxable year 1987, and
that decision is now final. See secs. 7481(a)(1), 7483. Because
the operative facts are largely the same for both 1986 and 1987,
we nevertheless shall speak to both years.
134
See app. 17 to this report.
 -331-

power of appointment with respect to each trust. In this

connection, the trust instrument provided, in pertinent part:

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 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 benefit of any person,
persons, or charitable organization * * *

Kanter asserted that, by January 20, 1977, he had renounced

all beneficial interests in the Bea Ritch Trusts.

At some unknown point before 1987, 60 trusts (the various

JSK Trusts) were added as beneficiaries of the Bea Ritch Trusts.

Exhs. 135, 9187, 9269, 9270, 9271. The original and additional

beneficiaries of each of the Bea Ritch Trusts are set forth in

detail in appendix 17. Kanter was the trustee for each of the 60

additional trusts which became the beneficiaries of the Bea Ritch

Trusts. Exhs. 9187, 9269, 9270, 9271.

No evidence was introduced at trial as to terms of, or the

identity of the beneficiaries of, the 60 additional trusts that

became beneficiaries of the Bea Ritch Trusts. No evidence was

introduced at trial as to how the 60 trusts were appointed

beneficiaries of the Bea Ritch Trusts.
 -332-

As of January 1, 1987, the Bea Ritch Trusts possessed

substantial assets and financial net worth. Since their

inception, each of the 25 trusts filed Federal income tax returns

for the fiscal year ending September 30. On their returns

covering the period 1969 to 1986, the trusts, collectively,

reported substantial income, deductions, and losses from numerous

investments. These investments included the trusts’ ownership of

all of IRA’s outstanding stock, their ownership of substantial

stock interests in THC, and their acquisition in 1973 of a

collective 18-percent interest in the Oyster Bay Associates

Partnership that invested in a cable television venture.

B. Oyster Bay Associates Partnership

Prior to the 1970s, Kanter initiated a practice at his law

firm, Levenfeld and Kanter (Levenfeld/Kanter), under which the

law firm’s partners, their family members, and/or their family

entities were offered the opportunity to participate in various

investment opportunities that came to the attention of Kanter and

other members of the firm. Participation in these investments

was on a voluntary and individual basis. A partner (or that

partner’s family members or family entities) was allowed to

subscribe to, and obtain a maximum percentage ownership interest

in, the investment equal to that partner’s law firm partnership

percentage interest. In the event any partner decided either (1)

not to participate, or (2) not to invest up to the initial
 -333-

maximum ownership interest amounts for that partner, then the

unsubscribed portion of the investment was available to other

partners desiring an increased investment. By investing and

taking part in a particular investment opportunity, the partners

were acting individually, and not as a law firm. They

and/or their families made such investments on their own behalf

and were not investing on the law firm’s behalf. Pursuant to

this practice, Kanter and the Bea Ritch trusts invested, during

the 1970s, in a number of investment opportunities that came to

the attention of Kanter and the law firm’s other partners.

On September 1, 1973, a number of Levenfeld/Kanter’s

partners joined in forming a partnership known as Oyster Bay

Associates (OBA). Statland Exh. 2; Statland, Baskes Transcr. on

5/27/87 (PM) (hereinafter Baskes Transcr.) at 6-13. OBA’s

partners included Levenfeld/Kanter partners, entities owned by

Levenfeld/Kanter partners, or members of their families. Id.

Each Levenfeld/Kanter partner or his family entity that became a

partner of OBA shared in the profits and losses of OBA in the

same percentage in which the partner shared in the profits and

losses of Levenfeld/Kanter in 1973. Baskes Transcr. at 12-13.

The partners contributed to OBA total capital of $100,000.

Statland Exh. 14. During 1974, OBA’s partners received
 -334-

distributions greater than their 1973 capital contributions to

OBA. Statland Exh. 14.

Kanter chose to participate in OBA. Statland Exh. 2; Baskes

Transcr. at 7-13. Kanter could have participated personally in

OBA but designated the Bea Ritch Trusts to participate in OBA up

to his 18-percent interest in Levenfeld/Kanter. Id. The Bea

Ritch Trusts acquired an 18-percent partnership interest in OBA

and contributed $18,000 to OBA. Statland Exhs. 2, 14. During

1974, the Bea Ritch Trusts received distributions from OBA

greater than the capital contributions of $18,000 they made to

the partnership in 1973. Statland Exh. 14.

On September 1, 1973 (the same day OBA was formed), an

Illinois general partnership, Long Island Cable Communications

Development Co. (Long Island Cable), was formed. Statland Exh.

2B. Long Island Cable’s partners included class A partners and

one class B partner, OBA. Id. The Long Island Cable partnership

agreement stated the partnership was formed to negotiate for the

purchase of certain existing franchise rights and equipment

collectively constituting a cable television system in Nassau

County, New York, and thereafter to operate those franchise

rights by the construction of additional cable communication

facilities and marketing those facilities in New York and/or

Illinois. Id.
 -335-

Long Island Cable’s class A partners, their percentage

interests, and their capital contributions 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

Id. at 7.

Long Island Cable’s partnership agreement provided that OBA

(the class B partner) agreed to contribute or secure additional

partners to contribute all additional cash required to advance

the business of Long Island Cable. Id. at 2. The Long Island

Cable partnership agreement also provided that the profits and

losses of Long Island Cable were to be shared by the class A

partners in their respective partnership percentage interests

until January 1, 1977, or the first date the class B partner,

OBA, was called upon to contribute capital to Long Island Cable,

whichever date occurred earlier, and thereafter the profits and

losses were to be shared seven-eighths by the class A partners

and one-eighth by the class B partner, OBA. Id. at 2-3.

On January 25, 1974, a New York limited partnership, Long

Island Cable Communications Development Co. (LICCDC), was formed.

Statland Exh. 3A. LICCDC’s general partners were Communications

Development Long Island Corp., a New York corporation (CDLIC),
 -336-

Communications Management Corp., a Delaware corporation (CMC),

and Charles F. Dolan (Dolan). Id. at 1-2. OBA owned all of the

stock of CMC. Exh. 7319 (next to last page). Kanter was the

president and Baskes was the vice president of CMC. Id.

LICCDC’s limited partners included class A and class B

participants. Statland Exh. 3A, at 4. The class A participants

consisted of various persons who contributed to the partnership

cash of $1,015,000 and $485,000 in 1974 and 1975, respectively.

Statland Exh. 3, at 3-4. The class B participants consisted of

OBA and Eagle Ventures, Inc. (EV). Id. at 4.

The LICCDC partnership agreement provided that LICCDC was

formed to carry on the business of constructing, owning,

altering, repairing, financing, operating, promoting, and

otherwise exploiting one or more cable television systems in

Nassau and Suffolk Counties in the State of New York. Statland

Exh. 3A, at 2. The LICCDC partnership agreement stated:

Any additional cash required to complete the equity
portion of the 450 mile addition of the Oyster Bay
system which cannot 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. [Id. at 4-5.]

Article 6.4 of the LICCDC partnership agreement stated: “payment

from the General Partner or from the Class B Participants is due
 -337-

and payable within forty-five (45) days of any call therefor by

the General Partner”. Id. at 5. The General Partner, as defined

in the partnership agreement, included Dolan, CDLIC, and CMC.

Id. at 22-24; Exh. 7319 (next to last page).

The LICCDC partnership agreement provided that profits and

losses would be shared as follows: 99 percent by the class A

participants and 1 percent by Dolan until January 1, 1977; if

payout had not occurred by January 1, 1977, then 5.5 percent to

Dolan and CDLIC, 83.5 percent to class A participants, and 11

percent to class B participants, respectively, until payout

occurred; and after payout (or after January 1, 1977, if it had

occurred by then, 64 percent to Dolan and CDLIC, 1 percent to

CMC, 22.5 percent to class A participants, and 12.5 percent to

class B participants, respectively. Statland Exh. 3A, at 6-7.

Payout was defined to occur on the date on which the cumulative

cashflow, which was to have been distributed to the partners

since the inception of the partnership, equaled or exceeded

$1,500,000. Id. at 7.

Class C and D interests in LICCDC were created by an

amendment to the LICCDC partnership agreement on January 1, 1975.

Statland Exh. 4. On the same day, Dolan and OBA formed the

Hempstead-Babylon Partnership (HB) to acquire the class C and D

interests. Statland Exh. 5. Within 10 days, on January 10,
 -338-

1975, the class C interests were sold to Nassau/Suffolk

Cablevision Investors for $4,500,000. Statland Exh. 5B.

Levenfeld/Kanter’s law firm partners sometimes raised

capital for investments and businesses owned by the firm’s

clients. Statland Exh. 23. Kanter and other Levenfeld/Kanter

partners participating in OBA solicited and obtained from various

investors the funds OBA promised to contribute to LICCDC.

Kanter, Transcr. at 4591, 4681-4684; Exhs. 7312, 7313, 7315-7318;

Statland Exhs. 6, 22-24, 26; Statland Exh. 53 (Dolan Deposition),

at 69-71, 129, 130, 138, 165, 179, 194; Baskes Transcr. at 37-41.

Kanter personally solicited investors for LICCDC including, but

not limited to, Genesis Ventures and Hugh Hefner. Exhs. 7310,

7311; Kanter, Transcr. at 4683-4684. As a result of the funds

raised by Kanter and other Levenfeld/Kanter partners for LICCDC,

OBA never contributed more than $2,000 in cash or property to

LICCDC. Statland Exhs. 12, 16-19; Baskes Transcr. at 33-34.

In exchange for the funds Kanter and other Levenfeld/Kanter

partners raised for LICCDC, OBA received its interest in LICCDC

and additional interests in LICCDC through additional

partnerships including HB, Bergen-Westchester (BW), and Yorkshire

Partners (YP) for which OBA paid no cash or other property.

Statland Exhs. 5, 10; Exh. 7307; Statland Exhs. 12, 16-19; Baskes

Transcr. at 33-34; Statland Exh. 53 (Dolan Deposition), at 71.
 -339-

As of June 13, 1978, LICCDC changed its name to Cablevision

Systems Development Co. (Cablevision). Statland, Exh. 20.

In about 1984, one of Kanter’s former law partners, Donald

Statland, commenced an action in Illinois State court against

Kanter and other Levenfeld/Kanter partners in an action captioned

Statland v. Levenfeld, et al., No. 84 CH 6494 (the Statland

case), concerning their involvement in Cablevision. Statland

alleged, among other things, that the Levenfeld/Kanter partners,

in substantial part, had obtained their and/or their families’

Oyster Bay Associates partnership interests in exchange for the

law firm’s services and the law partners’ efforts to recruit

unrelated, third-party investors. Statland claimed he was

entitled to a share of the Oyster Bay Associates partnership

interests because those partnership interests represented law

firm partnership income. Ultimately, the Illinois State court

ruled against Statland and held, among other things, that

Statland was not entitled to a share of the Oyster Bay Associates

partnership interests.

The Bea Ritch Trusts’ tax returns for the fiscal year ended

September 30, 1987, included aggregate net long-term capital

gains from the HB, BW, and YB partnerships of $1,143,248,

$274,660 and $615,460, respectively. Exh 9186. HB, BW, and YP

recognized these capital gains when they sold (during 1986)
 -340-

interests in LICCDC/Cablevision. Exhs. 9186, HB, BW and YP

Schedules K-1; 7307. As discussed above, the Bea Ritch Trusts

acquired their HB, BW, and YP partnership interests indirectly

through their partnership interests in OBA. Exh. 9186, HB, BW

and YP Schedules K-1.

Over the years, the Bea Ritch Trusts made substantial loans

to Kanter. TACI’s general ledger reflects that Kanter borrowed

$150,000 from the Bea Ritch Trusts during 1986 and repaid $10,000

to the trusts during that year. Exh. 9110 (ledger tab). As of

January l, 1987, Kanter owed a total of $287,030 to the Bea Ritch

Trusts.135 As of January 1, 1989, Kanter owed the trusts

$1,311,430 as a result of additional loans from the trusts.

Kanter also borrowed substantial sums from IRA and THC during the

period 1987 to 1989. Exhs. 9110 (TACI ledger for 1986), 9111

(Kanter ledger for 1987, Bates No. 000106), 9114.

Respondent determined in the notice of deficiency issued to

the Kanters for 1987 that the Bea Ritch Trusts were Kanter’s

grantor trusts under section 671. Respondent further determined

that, as such, all or portions of the following items constituted

taxable income, losses, or deductions of Kanter: (1) $1,094,896

135
The foregoing suggests that, as of Jan. 1, 1986, Kanter
owed approximately $147,000 to the Bea Ritch Trusts. Exhs. 9110
(TACI ledger for 1986), 9111 (Kanter ledger for 1987, Bates No.
000106).
 -341-

of the trusts’ gross receipts; (2) $295,298 of the trusts’

interest income; (3) dividend income of $325; (4) passive

activity partnership losses totaling $261,040; (5) $3,094,058 of

net capital gain income;136 and (6) certain investment interest

expenses.

OPINION

A. Grantor Trust Provisions of Sections 671 Through 678

Section 671 provides that if the grantor or another person

is treated as the owner of all or a portion of a trust under

sections 672 through 678, that person must include in income all

136
The STJ report, at 115 note 49, recommended that
respondent should not be permitted to argue on brief that
$2,033,368 of this adjustment represented long-term capital gain
realized by the Bea Ritch Trusts in 1986 (as opposed to 1987)
attributable to investments in Oyster Bay Associates Partnership
(OBA). We reject the recommendation in the STJ report that
respondent’s assertion on this point represented a “new matter”
not properly before the Court. A review of the record reveals
(1) Kanter’s tax liability for 1986 is at issue at docket No.
26251-90, (2) Kanter was not surprised or prejudiced with regard
to the matter because his counsel elicited testimony from
Gallenberger that the income was recognized in 1986
(Gallenberger, Transcr. at 4483-4485); (3) respondent promptly
made an oral motion to conform the pleadings to the proof and
respondent’s motion apparently was granted (Transcr. at 4495-
4500), (4) Kanter did not identify any evidence which he was
prevented from introducing as a result of respondent’s motion,
and (5) respondent’s assertion that the item is taxable to Kanter
in 1986 is not inconsistent with the original determination that
the Bea Ritch Trusts were Kanter’s grantor trusts, it did not
require new evidence, and it merely reflected a good-faith error
in the timing of when specific income was earned. Consistent
with this Court’s holding in Achiro v. Commissioner, 77 T.C. 881,
890 (1981), respondent’s oral motion to amend the pleadings will
be granted, and we decline to shift to respondent the burden of
proof on this point.
 -342-

items of income, deductions, and credits attributable to the

portion of the trust of which the person is deemed the owner.

Sections 672 through 678 prescribe a number of detailed rules

with respect to various circumstances under which a grantor or

other person will be deemed the owner of all or a portion of a

trust. For example, section 674(a) generally provides a grantor

will be treated as the owner of any portion of a trust whose

income, without the approval of an adverse party, is subject to a

power of disposition held by the grantor or a nonadverse party.

In still another instance, section 675(3) provides a grantor will

be treated as the owner of any portion of a trust in respect of

which the grantor has directly or indirectly borrowed the corpus

or income of the trust, where the grantor has not completely

repaid the loan, including interest, before the beginning of the

taxable year. However, section 675(3) does not apply to a loan

from the trust bearing an adequate interest rate and having

adequate security, if the loan is made by an independent trustee

to the grantor.

In applying the grantor trust rules described above, the

principle of substance over form is particularly applicable

considering the potential for manipulation of trusts. See Zmuda

v. Commissioner, 79 T.C. 714 (1982), affd. 731 F.2d 1417 (9th

Cir. 1984); Lazarus v. Commissioner, 58 T.C. 854, 864 (1972),

affd. 513 F.2d 824 (9th Cir. 1975). The grantor of a trust may
 -343-

be the person who actually funded the trust as opposed to the

person named as the grantor in the trust instrument. United

States v. Buttorff, 761 F.2d 1056, 1060-1061 (5th Cir. 1985);

Schulz v. Commissioner, 686 F.2d 490, 496 (7th Cir. 1982), affg.

T.C. Memo. 1980-568. In Schulz, for example, the taxpayer’s wife

was considered the grantor of a family trust because the

conveyance of the wife’s assets to her husband (which were used

to fund the trust) was disregarded.

B. The Parties’ Arguments

Petitioners contend the Bea Ritch Trusts were not Kanter’s

grantor trusts during 1986 or 1987. Petitioners assert Kanter’s

mother, not Kanter, was the trusts’ nominal and true settlor.

Although the 25 trusts made a number of profitable investments

attributable to Kanter’s advice and recommendations to Weisgal

(the trusts’ trustee), petitioners maintain Weisgal made all

final investment decisions for the trusts.

Respondent, on the other hand, advances a number of

arguments in contending the 1986 and 1987 adjustments to Kanter’s

income should be sustained. Respondent contends Kanter is the

true settlor of the Bea Ritch Trusts as evidenced by the

substantial amounts he transferred to or for the benefit of the

trusts over the years including (1) his share of payments from

The Five to IRA and THC (discussed supra, Issue I) in which the

Bea Ritch Trusts held substantial stock interests), (2) Kanter’s
 -344-

share of fees paid to Century Industries during 1981 to 1984 and

1986 (discussed supra, Issue III), with regard to which the

trusts ostensibly held a 49-percent partnership interest, (3) the

fees Kanter earned during 1981 to 1983 from Hi-Chicago Trust

which Kanter attempted to assign to THC (discussed supra Issue

IV) in which the trusts held substantial stock interests, and (4)

the 18-percent partnership interest the trusts acquired in OBA.

Respondent also asserts that sections 674(a) and 675(3) apply

under the facts presented so as to attribute to Kanter all of the

trusts’ income for 1986 and 1987.

C. The STJ Report

The STJ report, at 119-121, recommended holding (1) Kanter

had not transferred to the Bea Ritch Trusts substantial amounts

of income he earned from providing services to others, and (2)

Kanter was not the “true settlor” of the Bea Ritch Trusts. The

STJ report recommended accepting Kanter’s testimony in which he

denied he was paid anything for his assistance in bringing in

unrelated investors to the Cablevision project.

As discussed below, the objective evidence of record

indicates Kanter transferred substantial sums of his own income

to the Bea Ritch Trusts (directly and through IRA and THC) and

Kanter (through the Bea Ritch Trusts) was compensated with

partnership interests in LICCDC/Cablevision in exchange for

recruiting investors for the Cablevision project. Viewed in the
 -345-

light of the entire record, the credibility determinations and

recommended holding in the STJ report were manifestly

unreasonable.

D. Analysis

In determining whether Kanter was the true settlor of the

Bea Ritch Trusts, we begin with the manner in which the trusts

were funded. The record indicates that if Bea Ritch transferred

any of her own assets to the 25 Bea Ritch Trusts, she transferred

no more than $100 to each trust or a total of $2,500.

Notwithstanding the lack of any evidence that Bea Ritch

transferred additional amounts to the Bea Ritch Trusts, Kanter

invites us to conclude the Bea Ritch Trusts were so deftly

managed that they were able to grow $2,500 in 1969 into many

millions during the years at issue without the benefit of

assignments of his earnings. Kanter did not introduce any

evidence indicating the trusts’ early investments were so

extraordinarily successful. We decline to accept such a

proposition where the record so clearly demonstrates (1) moneys

Kanter earned and assigned to or for the benefit of the Bea Ritch

Trusts represented the primary source of the trusts’ increasing

asset base, and (2) Kanter liberally used the Bea Ritch Trusts as

a source of loans.

We have already determined Kanter employed IRA and THC as

shams to receive, and shelter from taxation, income which Kanter
 -346-

personally earned from a variety of transactions. Kanter

attempted to assign to IRA and THC substantial amounts of income

which he earned in the form of payments from The Five. The Bea

Ritch Trusts owned all of IRA’s common stock, and they held a

substantial interest in THC.

Similarly, we conclude Kanter attempted to assign to Century

Industries (in which the Bea Ritch Trusts purportedly held a 49-

percent partnership interest) fees he earned evaluating

investment opportunities for various third parties. Kanter

employed the same tactics in attempting to improperly assign to

THC substantial fees he earned serving as trustee/investment

manager for Hi-Chicago Trust. Thus, during the period 1977 to

1989, the record reflects Kanter engaged in an active and

sustained campaign to transfer his income to IRA, THC, and other

Kanter-related entities for the ultimate benefit of the Bea Ritch

Trusts. We conclude Kanter is the grantor of the Bea Ritch

Trusts.

In connection with the foregoing, Kanter failed to offer any

rational explanation for the addition of 60 trusts as

beneficiaries of the Bea Ritch Trusts after Kanter purportedly

renounced his interests in those trusts. Kanter was the only

person vested with the power under the instrument creating the

Bea Ritch Trusts to appoint new trust beneficiaries. Under the

circumstances, we infer Kanter appointed the new beneficiaries
 -347-

and his earlier renunciations were, for all practical purposes,

meaningless gestures.

In sum, we hold Kanter was the true settlor of the Bea Ritch

Trusts--he funded the trusts over a period of many years, and he

retained at all times a power to appoint the beneficiaries of the

Bea Ritch Trusts that was tantamount to a power of disposition

over the trusts’ assets. See secs. 671, 674(a); sec. 1.671-

2(e)(1), Income Tax Regs. (“[A] grantor includes any person to

the extent such person either creates a trust, or directly or

indirectly makes a gratuitous transfer * * * of property to a

trust. * * * If a person creates or funds a trust on behalf of

another person, both persons are treated as grantors of the

trust.”); sec. 1.674(a)-1, Income Tax Regs. Consequently, Kanter

is taxable on the income of the Bea Ritch Trusts for 1986 and

1987.137

The Cablevision transactions in 1986 and 1987 were

additional examples of Kanter’s preferred modus operandi. In

particular, Kanter allowed the Bea Ritch Trusts to subscribe to

the 18-percent partnership interest in OBA to which he was

otherwise entitled. Although the Bea Ritch Trusts invested

$18,000 in OBA, as discussed above, those funds in all likelihood

137
To the extent we have already determined certain
payments to Century Industries (for the year 1986) constituted
Kanter’s income, that income should not be attributed to Kanter a
second time when computing his income for 1986 as the grantor of
the Bea Ritch Trusts.
 -348-

derived from earnings Kanter assigned to or for the benefit of

the trusts. Moreover, the record shows that OBA received its

interest in LICCDC/Cablevision and the additional related

partnership interests in HB, BW, and YP solely in exchange for

Kanter’s and other Levenfeld/Kanter partners’ efforts to raise

capital for LICCDC/Cablevision. Thus, the Bea Ritch Trusts’

partnership interests in HB, BW, and YP (acquired through OBA)

represented nothing more than Kanter’s compensation for

recruiting additional investors for the Cablevision project.138

Once again, Kanter improperly attempted to assign to the Bea

Ritch Trusts income he earned as payments for his personal

services. Accordingly, we hold Kanter, as grantor of the Bea

Ritch Trusts, is taxable on the trusts’ income for 1986 and 1987.

138
Petitioners rely on the holding in Statland v.
Levenfeld, Case No. 84 CH 6494, Circuit Court of Cook County,
Illinois, Decision entered Jan. 28, 1988 (Exh. 9195), as proof
that Kanter, his law firm partners, their family members, and
other family entities that invested in OBA did not obtain their
partnership interests in exchange for services the law firm
performed. Although this point may be true, there is no dispute
Kanter assisted Cablevision in finding additional investors. We
conclude he was compensated for these efforts (as opposed to his
legal services) with partnership interests in HB, BW, and YP.
 -349-

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

FINDINGS OF FACT

Respondent determined in notices of deficiency issued to the

Kanters for 1982 to 1984 and 1987 to 1989 that Kanter failed to

report income of $191,461, $232,900, $290,785, $29,998, $127,249,

and $279,596, respectively.140 As discussed in detail below,

these adjustments are attributable to respondent’s determination

that Kanter attempted to assign to THC income that he earned in

respect of transactions involving CMS Investors Partnership (CMS

Investors).

Much as in the Cablevision transaction (discussed supra

Issue V), members of the Levenfeld/Kanter law partnership and/or

entities established for the benefit of their families were

offered and acquired partnership interests in CMS Investors

during 1978. Kanter, Transcr. at 4105-4107; Exh. 9134. Kanter

139
The Court’s disposition of this issue represents in
large measure a wholesale adoption of the recommended findings of
fact and conclusions of law set forth in the STJ report.
140
These adjustments were resolved in petitioners’ favor
and the decisions entered by the Court at docket Nos. 24002-91
(taxable year 1987), 26918-92 (taxable year 1988), and 25981-93
(taxable year 1989), on Sept. 24, 2001, were not appealed, and
are otherwise final. See secs. 7481(a)(1), 7483. Respondent,
however, challenges the recommended findings of fact and
conclusions of law in the STJ report, and, therefore, we are
obliged to address the CMS Investors Partnership issue for 1982
to 1984.
 -350-

permitted THC to invest in his share of the CMS Investors

offering. Kanter, Transcr. at 4198-4199.

Delta Partnership (Delta) was formed on the same date that

CMS Investors was formed and CMS Investors acquired a 95.5-

percent partnership interest in Delta. Exh. 9135. Alpha

Partnership (Alpha) was formed in May 1979, and CMS Investors

acquired an 85.5-percent partnership interest in Alpha. Exh.

9136.

In 1978, Delta made a substantial loan to another

partnership, Shelburne Associates (Shelburne), which the latter

used to purchase several feature-length motion pictures. Exh.

9137. In 1979, Alpha made a substantial loan to another

partnership, Century Associates (Century), which the latter used

to purchase several feature-length motion pictures. Exh. 9138.

Respondent concedes Shelburne and Century both paid

substantial legal fees to the Levenfeld/Kanter law firm.

Respondent’s Opening Brief at 920, par. 1382.

Shelburne and Century subsequently transferred to Delta and

Alpha substantial amounts, characterized as bonus payments, and

CMS Investors received distributable shares of these bonus

payments as a partner in Delta and Alpha. THC, a CMS Investors

partner, in turn received its distributable share of the bonus

payments. THC reported these payments as income on its income
 -351-

tax returns. As indicated, respondent determined that THC’s

share of the Shelburne and Century bonus payments represented

Kanter’s income.

This Court, in Durkin v. Commissioner, 87 T.C. 1329 (1986),

affd. 872 F.2d 1271 (7th Cir. 1989), passed upon and made certain

factual conclusions regarding the loan by Delta to Shelburne

under which loan one of the bonus payments in dispute in these

case was made. Under the terms of both loans, Shelburne and

Century, as the debtors, were required not only to pay principal

and interest to Delta and Alpha, but Shelburne and Century were

also required, under certain conditions, to pay Delta and Alpha

certain amounts referred to as bonus payments. These bonus

payments were in fact paid, and both Shelburne and Century

treated these bonus payments as interest and claimed deductions

of such payments for income tax purposes. In Durkin v.

Commissioner, supra, this Court held the Shelburne bonus payment

did not constitute compensation for the use of money and,

therefore, it was not deductible as interest. The Court further

held the bonus payment essentially was nothing more than a

mechanism to divert funds from Shelburne to Delta (and on to CMS

Investors), “thereby increasing the income of the partnerships

and trusts associated with or established for the benefit of the

members of the law firm or their immediate families.” Durkin v.

Commissioner, supra at 1400.
 -352-

The parties here do not dispute the factual findings or the

holding of the Court in Durkin v. Commissioner, supra. Nor do

the parties deny that the bonus payments constitute income to the

recipient partnerships.

On brief, respondent acknowledges Durkin did not

address the question whether the family entities or the

Levenfeld/Kanter law partners, individually, were taxable on the

bonus payment paid by Shelburne to Delta. Respondent

nevertheless argues Kanter is taxable on the share of the bonus

payments paid by Shelburne and Century to Alpha and Delta,

respectively, that flowed through CMS Investors to THC.

OPINION

A. The Parties’ Arguments

Petitioners contend the Court lacks subject-matter

jurisdiction because the Levenfeld/Kanter law firm was a TEFRA

partnership during the years at issue, and, in fact, respondent

issued an FPAA to the law partnership for 1994 which included the

subject adjustment. Petitioners also contend respondent is

collaterally estopped from attributing the income at issue to

Kanter by virtue of the Court’s holding in Durkin v.

Commissioner, supra. Finally, petitioners contend THC (as

opposed to Kanter) was a partner in CMS Investors and should be

recognized as such.
 -353-

Respondent maintains that the portions of the bonus payments

that eventually made their way to THC represent income taxable to

Kanter under the assignment of income doctrine. See Lucas v.

Earl, 281 U.S. 111 (1930). Respondent argues (1) the bonus

payments were not paid for the use of funds but were used as a

means to divert funds from Shelburne and Century to CMS

Investors’ partners, and (2) the bonus payments represented

income earned by the individual partners of the Levenfeld/Kanter

law partnership “through their actions in creating the right to

receive the bonus payments and diverting them to their respective

family entities.” Respondent’s Opening Brief at 927.

Respondent’s position apparently is based on the Court’s

finding in Durkin v. Commissioner, supra, that the Shelburne

bonus payment to Delta was not made for the use of money but was

a mechanism to divert funds to CMS Investors and the various

entities established for the benefit of the Levenfeld/Kanter law

partners and/or their immediate families. Respondent argues

there was no need for the loans to Shelburne and Century because

Shelburne and Century would, in due course, realize funds from

movie revenues that would alleviate the need for such financing.

Therefore, respondent asserts, the loans were structured merely

to create purported payments of interest which were, in effect,

payments to Kanter and his law firm for legal services the firm

provided in connection with movie syndications.
 -354-

Respondent further asserts that the purpose of diverting the

bonus payments to CMS Investors, which flowed through to THC and

other Levenfeld/Kanter family entities, was the “improper

avoidance of income, gift and estate taxes” because THC had large

operating losses and, therefore, paid no income taxes on the

bonus payments received.

B. Analysis

1. Subject Matter Jurisdiction

The jurisdictional question presented here turns on whether

the bonus payments, in fact, were income to the Levenfeld/Kanter

law partnership (which would make the adjustments partnership

items subjected to the TEFRA partnership provisions). As

previously discussed, the Court generally lacks jurisdiction in a

deficiency proceeding brought under section 6213(a) to review

adjustments to partnership items as defined under the TEFRA

partnership procedures.

Pursuant to a longstanding practice, Levenfeld/Kanter’s law

partners were offered the opportunity to acquire partnership

interests in CMS Investors (and indirectly Delta and Alpha).

Participation was voluntary, and investments were made by a law

firm member, a member’s immediate family, and/or a family entity

for their own accounts and not on behalf of the law partnership.

Some of the law firm partners elected not to participate in the

CMS Investors offering. The Levenfeld/Kanter law partnership did
 -355-

not have any interest in or rights to the income from the

venture.

Delta’s and Alpha’s loans to Shelburne and Century were not

investment activities of the Levenfeld/Kanter law partnership.

The law firm members who participated in these ventures had no

intention to invest on the law firm’s behalf. More importantly,

the alleged diversions of funds from Shelburne and Century (in

the form of the bonus payments) were not joint business endeavors

of Levenfeld/Kanter’s law partners, as only those members of the

law firm and/or their families who invested in CMS Investors (and

Delta and Alpha) would benefit from the bonus payments.

On the record presented, the Court concludes the bonus

payments were not income attributable to the Levenfeld/Kanter law

partnership. Consequently, the Court has subject matter

jurisdiction over the CMS Investors income adjustments at issue

in the instant deficiency cases inasmuch as they do not

constitute partnership items within the meaning of section

6231(a)(3).141

141
The CMS Investors income adjustments at issue likewise
do not constitute partnership items to CMS Investors. The only
question remaining before the Court is whether Kanter, as opposed
to THC, should be treated as the true and actual partner in CMS
Investors. Resolution of that issue does not require a
determination concerning a partnership item within the meaning of
sec. 6231(a)(3). See, e.g., Grigoraci v. Commissioner, T.C.
Memo. 2002-202.
 -356-

2. Whether Kanter Improperly Assigned Income to THC Through
CMS Investors

Respondent does not dispute that Delta and Alpha lent

millions of dollars to Shelburne and Century, respectively. In

Durkin v. Commissioner, 87 T.C. 1329 (1986), this Court concluded

the Delta loan constituted a valid debt for tax purposes.

Respondent’s theory, nevertheless, is that THC’s distributive

share of the bonus payments from Shelburne and Century represents

Kanter’s income because Kanter (and other members of his law

firm) were the true investors and the true lenders, and THC (as a

partner in CMS Investors) was, in effect, no more than an alter

ego for Kanter. On the record presented, we disagree.

In Durkin v. Commissioner, supra at 1399-1401, the Court

held that the Shelburne bonus payment did not constitute interest

and, therefore, it was not deductible. The Court also suggested

the Shelburne bonus payment was simply a distribution of profits

from Shelburne to CMS Investors disguised as an interest payment.

Id. at 1400. From these points, respondent infers that the loans

giving rise to the bonus payments were, in effect, loans made by

Kanter and his law partners. Respondent goes well beyond the

holding of Durkin. The Court in Durkin made no such finding, and

respondent has misinterpreted the case.

We reject the argument that Kanter attempted to assign to

THC the income from the bonus payments. Although we have

concluded Kanter used THC as a conduit to receive his share of
 -357-

some of the payments from The Five, as well as income that he

earned providing services to Hi-Chicago Trust, this transaction

does not fit that mold. The payments to THC from The Five and

Hi-Chicago Trust represented compensation to Kanter for personal

services. Here, however, there is no evidence Kanter provided

any personal services or assistance to CMS Investors, Alpha,

Delta, Shelburne, or Century. Rather, Delta and Alpha made bona

fide loans to Shelburne and Century. Under the circumstance, we

see no justification for concluding that THC served as Kanter’s

alter ego for purposes of this transaction. Without more, THC’s

distributive share of CMS Investors’ partnership items must be

respected. Accordingly, we hold Kanter is not taxable on the

income which flowed through CMS Investors to THC for the taxable

years 1982, 1983, 1984.142

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

FINDINGS OF FACT

Respondent determined in the notice of deficiency issued to

the Kanters for 1983 that Kanter failed to report income of

$635,250 for that year. As discussed in detail below, this

adjustment is attributable to respondent’s determination that

Kanter attempted to assign to THC and Zion income he earned from

142
Consequently, we need not address Kanter’s collateral
estoppel argument.
 -358-

transactions involving Equitable Leasing Co., Inc. (Equitable

Leasing).

Joel Mallin (Mallin) was a good friend and former law

partner of Kanter who organized and promoted various equipment

leasing transactions through Equity Leasing, his wholly owned

company. Kanter, Transcr. at 4749; Mallin, Transcr. at 5172-

5175. Mallin’s leasing transactions were highly leveraged, and

the residual value of the leased equipment provided the

ostensible paper profit on his investors capital. Mallin,

Transcr. at 5175-5186.

During 1983, Kanter allowed Mallin to include Zion as an

investor in some of Equitable Leasing’s offerings so that the

offering would be fully subscribed and could close. Kanter,

Transcr. at 4752. During 1983, Kanter also introduced additional

investors to Mallin so that Equitable Leasing could complete

certain transactions. Kanter, Transcr. at 4753, Mallin, Transcr.

at 5213-5215.

During 1983, Equitable Leasing transferred funds totaling at

least $635,250 to THC and Zion, as follows:

Date Amount Payee Exhibit

1/4/83 $317,250 Zion 9203; 146, at 6 (AJE 32)
1/24/83 9,500 THC 9203; 146, at 2 (AJE 8)
6/1/83 6,500 Zion 9203, at 9
6/30/83 302,000 THC 9203; 148, at 12
 -359-

Exh. 146, at 2 (AJE 8), provides an entry for $24,500 and states

“Commission Income Consulting Fees to reclass C/R from Equitable

Leasing on 9/21/82 & 1/25/83.” It appears this $24,500 entry

pertains to a $15,000 item from September 1982 combined with the

$9,500 item dated January 24, 1983. As previously discussed,

Zion was a subsidiary of THC during the year 1983.

THC’s accounting records related to these transactions are

inconsistent and contradictory. THC recorded about half of the

funds it received from Equitable Leasing as loans and the other

half as commissions. Exh. 146, at 2, 6 (AJE’s 8 and 32); Exh.

148, at 12 (listing loans of $8,000 and $302,000 on June 27 and

30, 1983, respectively). However, THC’s records also include an

adjusting journal entry for $310,000 (which probably includes the

$302,000 transferred to THC on June 30, 1983, and the $8,000

listed as a loan on June 27, 1983, see Exh. 148, at 12) and which

appears to read: “N/P-Equitable Leasing, Commission Income, to

reclassify funds from Eq. Leasing [date illegible].” Exh. 146,

at 11 (AJE 59).

Mallin paid commissions to Kanter (through payments to THC

and Zion) in exchange for Kanter’s assistance in recruiting

investors for his leasing transactions. Kanter, Transcr. at

4753; Mallin, Transcr. at 5213-5214.
 -360-

OPINION143

The provision of section 61 that gross income includes all

income from whatever source derived would encompass fees and

commissions earned as compensation for services. THC and Zion

received payments from Equitable Leasing which were labeled

inconsistently as commissions and/or loans. Kanter asserts THC

and Zion “received certain amounts from Equitable Leasing in the

first six months of 1983 as an accommodation to allow Zion to

make investments in certain offerings Equitable Leasing was

promoting so that those offerings could become fully subscribed

and close.” Petitioners’ Reply Brief at 1245.

Respondent contends all the moneys Equitable Leasing

transferred to THC and Zion were commissions paid to Kanter to

compensate him for recruiting investors for Mallin’s equipment

leasing transactions. Kanter argues the funds in question were

loans. We agree with respondent.

The record shows: (1) Kanter recruited investors for

Equitable Leasing’s transactions, and (2) Mallin/Equitable

Leasing paid commissions for these services to Kanter-related

entities, THC and Zion. Against this evidence, Kanter offered

143
The STJ report recommended holding that respondent is
barred from making any determination concerning the taxable year
1983 on account of the expiration of the period of limitations
governing assessment and collection for that year. As previously
discussed, we determined that Kanter’s income tax returns for the
years at issue were fraudulent, and, therefore, the period of
limitations remains open pursuant to sec. 6501(c)(1).
 -361-

little in the way of rebuttal. Although THC’s accounting records

labeled some of the funds it received from Equitable Leasing as

loans, those entries were contradicted by other entries labeling

the payments as commissions. Kanter did not provide any

additional evidence such as promissory notes or proof of

principal or interest payments to corroborate THC’s records.

Given that Kanter controlled the entities involved, we resolve

any doubts engendered by the record in respondent’s favor.

Considering all the circumstances, we sustain respondent’s

determination that the funds that Equitable Leasing transferred

to THC and Zion during 1983 represented income that Kanter earned

during 1983 and that he attempted to assign to THC and Zion.

These payments are includable in Kanter’s income for 1983.

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

FINDINGS OF FACT

During 1982, Kanter made a total of approximately $2.8

million in deposits to his three bank accounts at American

National Bank at Chicago, Illinois. Kanter maintained a check

register in which he recorded the source and nature of the

deposits made to these accounts. In preparing the Kanters’ 1982

joint individual Federal income tax return, Linda Gallenberger,

Kanter’s accountant, used the check register to determine what

portion of his 1982 bank deposits represented taxable income.
 -362-

Respondent determined the Kanters failed to maintain or

provide adequate books and records with respect to their taxable

income for 1982. Respondent further determined Kanter had in

excess of $2 million in unreported income for 1982, which

unreported income determination was based upon respondent’s

analysis of deposits to Kanter’s three American National Bank

accounts. The deposit slips from which respondent reconstructed

Kanter’s 1982 taxable income did not specify the taxable or

nontaxable nature of the deposits.144 At trial, Kanter offered

into evidence his check register and a series of spreadsheets and

a summary analysis of his bank deposits prepared by Gallenberger.

Exhs. 9168-9172.

Respondent conceded a portion of the subject adjustment, but

maintains Kanter failed to report $1,303,207 of income for 1982

based on the bank deposits from the payors or sources in the

amounts listed below:

144
The record does not disclose whether the Kanters
provided the check register to the revenue agent who examined
their 1982 return. Apparently the revenue agent had been
unsuccessful in obtaining a number of documents requested from
the Kanters, as the agent attempted to reconstruct Kanter’s 1982
taxable income based upon an analysis of Kanter’s bank account
deposits. To obtain copies of the bank account statements and
other account information, the agent issued a third-party
administrative summons to the bank.
 -363-

Payor Or Source Funds Received Characterization

THC $787,129.17 Loan
Computer Placement Service 40,000.00 Loan
TACI Special E Account 190,077.83 Return of investment
TACI Special Account 286,000.00 Loan
Total 1,303,207.00

Transcr. at 4322.

OPINION

A. The Commissioner’s Use of the Bank Deposits Method of Income
Reconstruction

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. 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 great

latitude in selecting a method for reconstructing a taxpayer’s

income, and the method need only be reasonable in the light of

all the surrounding circumstances.

This Court has long accepted the bank deposits method of

income reconstruction. Nicholas v. Commissioner, 70 T.C. 1057,

1065 (1978); Estate of Mason v. Commissioner, 64 T.C. 651, 653

(1975), affd. 566 F.2d 2 (6th Cir. 1977). While not conclusive,

bank deposits are prima facie evidence of income. Boyett v.

Commissioner, 204 F.2d 205 (5th Cir. 1953), affg. a Memorandum
 -364-

Opinion of this Court; Hague Estate v. Commissioner, 132 F.2d 775

(2d Cir. 1943), affg. 45 B.T.A. 104 (1941).

Taxpayers generally bear the burden of proving that the

Commissioner’s determinations are erroneous; and in the case of a

bank deposits analysis, a taxpayer normally must show the

deposits came from a nontaxable source. Rule 142(a); Welch v.

Helverinq, 290 U.S. 111 (1933).

B. The Parties’ Arguments

Kanter contends respondent’s reconstruction of his income

for 1982 under the bank deposits method is arbitrary and

excessive. Kanter asserts (1) he maintained adequate records

(i.e., his check register) identifying the taxable and nontaxable

deposits to his bank accounts, and (2) respondent’s determination

should not be accorded its normal presumption of correctness.

With regard to the latter point, Kanter maintains respondent

should bear the burden of proof on this issue or respondent

should have the burden of going forward with the evidence.

Kanter further asserts the credible evidence of record (which

includes his check register and Gallenberger’s spreadsheets and

testimony) is sufficient to prove the deposits in question were

either proceeds of loans or return of investment funds.

Respondent contends Kanter has not satisfied his burden of

proof under Rule 142(a). Respondent argues the testimony and

other evidence petitioners offered should be disregarded as self-
 -365-

serving. Respondent asserts Kanter offered no credible

documentation substantiating the nontaxable nature of the

$1,303,207 of deposits at issue. Respondent emphasizes that two

of the disputed deposits are attributable to funds Kanter

received from the TACI Special E and TACI Special Accounts which

Kanter purportedly used to disguise payments to himself as loans.

C. The STJ Report

The STJ report recommended holding for Kanter on this issue

on the grounds that (1) Kanter and Gallenberger testified

credibly that the questioned deposits were either loans to Kanter

or returns of Kanter’s capital,145 (2) Kanter’s and Gallenberger’s

testimony was corroborated by Kanter’s check register, and (3)

respondent offered no evidence to rebut the above evidence and

testimony.

D. Analysis

Considering the large amounts of the bank deposits in

question and Kanter’s obfuscation during the examination process,

we cannot fault respondent for declining to accept Kanter’s check

register as an adequate record of his taxable income for 1982.

Without more, respondent was wholly justified in employing the

145
The STJ report, at 131-132, includes statements
suggesting that Kanter offered testimony regarding his bank
deposits for 1982 and that testimony was credible. The Court is
unable to find any citation of Kanter’s testimony on this point
in petitioners’ posttrial briefs, nor is the testimony apparent
from a review of the transcript.
 -366-

bank deposits method of income reconstruction to determine the

correct amount of Kanter’s taxable income for 1982.

Respondent’s determination was not a so-called naked

assessment, nor was it arbitrary or excessive. See, e.g.,

Weimerskirch v. Commissioner, 596 F.2d 358 (9th Cir. 1979), revg.

67 T.C. 672 (1977). Respondent offered ample evidence linking

Kanter to income-producing activities during 1982 including his

law practice and the fees and commissions Kanter earned from,

among others, The Five. Respondent identified four specific

deposits that were determined to represent unreported income.

Therefore, respondent’s determination of unreported income is

entitled to the normal presumption of correctness, and there is

no basis for shifting to respondent either the burden of proof or

the burden of going forward with the evidence. See, e.g., United

States v. Esser, 520 F.2d 213, 217 (7th Cir. 1975).

As indicated, the record includes Kanter’s check register,

Gallenberger’s spreadsheets and summaries, and Gallenberger’s

testimony regarding the methods she used in preparing the

Kanters’ tax return for 1982. Considering all the circumstances,

particularly Kanter’s and Gallenberger’s misconduct as outlined

by the District Court during the summons enforcement proceedings,

we conclude it was manifestly unreasonable to conclude Kanter’s

testimony (if it exists) and Gallenberger’s testimony was

credible. See United States v. Administration Co., 74 AFTR 2d
 -367-

94-5252, 94-2 USTC par. 50,479 (N.D. Ill. 1994); United States v.

Administration Co., 74 AFTR 2d 94-5256, 94-2 USTC par. 50,480

(N.D. Ill. 1994).

We conclude the evidence Kanter offered on this issue was

insufficient to satisfy his burden of proof. Given the large

amounts of the deposits in question, not to mention Kanter’s

experience as a tax attorney, Kanter should have been prepared to

offer additional records, such as loan documents, checks

reflecting prior investments, checks reflecting principal or

interest payments, or other accounting records in support of the

proposition that the deposits in question were in fact loans or

returns of capital. In the absence of such evidence, we sustain

respondent’s determination that Kanter failed to report

$1,303,207 of income for 1982.

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

Respondent determined in notices of deficiency issued to the

Kanters for 1988 and 1989 that Kanter failed to report barter

income he received from Principal Services Accounting Corp.

(PSAC) during those years. These adjustments were resolved in

petitioners’ favor, and the decisions entered by the Court at

docket Nos. 26918-92 (taxable year 1988) and 25981-93 (taxable

year 1989) on September 24, 2001, were not appealed and are
 -368-

otherwise final. See secs. 7481(a)(1), 7483.146 Consequently, we

need not consider this issue.

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

Respondent determined in the notice of deficiency issued to

the Kanters for 1988 that the Kanters failed to report interest

income they received during 1988. This adjustment was resolved

in petitioners’ favor, and the decision entered by the Court at

docket No. 26918-92 (taxable year 1988) on September 24, 2001,

was not appealed and is otherwise final. See secs. 7481(a)(1),

7483.147 Consequently, we need not consider this issue.

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

In notices of deficiency issued to the Kanters for 1986 to

1989, respondent disallowed deductions the Kanters claimed on

Schedules A and C of their tax returns for those years. These

adjustments were resolved in petitioners’ favor, and the

decisions entered by the Court at docket Nos. 24002-91 (taxable

year 1987), 26918-92 (taxable year 1988), and 25981-93 (taxable

year 1989) on September 24, 2001, were not appealed and are

otherwise final. See secs. 7481(a)(1), 7483.

146
Respondent does not challenge the ultimate conclusion in
the STJ report on this issue.
147
Respondent does not challenge the ultimate conclusion in
the STJ report on this issue.
 -369-

Respondent does not challenge the ultimate conclusion in the

STJ report regarding the Kanters’ deductions for the taxable

years 1987 to 1989. Respondent, however, does not state whether

he objects to the STJ report holding with regard to the Kanters’

Schedule A deduction for 1986. Therefore, we shall address the

question whether petitioners are entitled to the Schedule A

deduction in question for 1986.148

FINDINGS OF FACT

On Schedule A of the Kanters’ 1986 Federal income tax

return, the Kanters claimed a deduction of $368,227 in “Other

interest” expenses. In the notice of deficiency, respondent

determined that no deduction was allowable to the Kanters for the

$368,227 in interest expenses claimed for 1986. The notice of

deficiency stated in pertinent part:

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.

Therefore, your taxable income for 1986 is increased by
$368,227.

148
The Court’s disposition of this issue represents in
large measure a wholesale adoption of the recommended findings of
fact and conclusions of law set forth in the STJ report.
 -370-

For 1986, almost all of Kanter’s expenses claimed as deductions

on the Kanters’ tax return were paid through funds from TACI and

PSAC accounts. The funds used to pay Kanter’s expenses either

belonged to Kanter or were borrowed by him from other TACI and

PSAC clients.

During the course of the trial, petitioners began offering

evidence with respect to the above expenses as well as certain

1982 Schedule C deductions. Counsel for the parties then

requested and received a short recess in order to meet and

discuss off the record the various evidentiary and legal matters

pertaining to these expenses. The Court did not participate in

counsels’ deliberations.

Immediately following their conference, counsel for the

parties advised the Court that: (1) The Kanters were entitled to

deduct the 1982 Schedule C expenses, and (2) the 1987, 1988, and

1989 Schedule A and Schedule C expenses the Kanters claimed had

been substantiated, except that respondent (a) disputed that the

expenses paid out of funds from the TACI and PSAC accounts had

been paid by Kanter and (b) questioned whether the Kanters were

entitled to deduct expenses with respect to property held in

trust. Counsel made no mention as to whether this agreement

included the Kanters’ 1986 Schedule A deduction for interest

expenses. Transcr. at 3957-3960. However, counsel for

petitioners expressed to the Court their belief that the parties
 -371-

had narrowed the issues on all of the adjustments that were then

being heard by the Court. Counsel for respondent expressed no

disagreement with that assertion. Following the colloquy between

counsel for the parties and the Court, the trial resumed with

respect to the remaining issues as to which the parties were

unable to agree: (1) Whether payment of the subject expenses out

of the TACI Special E and PSAC Special accounts represented

payment by the Kanters, and (2) whether the Kanters were entitled

to a deduction for interest payments with respect to property

(the Kanters' personal residence) that was titled in a grantor

trust in which Kanter was the deemed owner.

During and after the trial, the parties filed several

stipulations of settlement. On May 15, 1995, the parties filed a

Stipulation Of Settlement As To Certain Issues Between

Petitioners Burton W. Kanter, Naomi R. Kanter, * * * [IRA], And

Subsidiaries, And Respondent. The May 15, 1995 Stipulation Of

Settled Issues listed a number of adjustments contained in the

notices of deficiency that the parties had settled, including an

“Unreported Fee Income” adjustment for 1986. The 1986 interest

expense the Kanters claimed was not listed among these settled

issues, nor was there any listing of the other Schedule A and

Schedule C expenses identified above for the various years in

question.
 -372-

OPINION

A. The Parties’ Arguments

The parties disagree whether their off-the-record

conference, during which they narrowed the issues then being

heard by the Court, included petitioners’ 1986 interest expense

deduction of $368,227. Petitioners contend their agreement

included the 1986 interest expense deduction, and reference to

its inclusion was inadvertently omitted in their representation

to the Court. Respondent disagrees and contends that all of the

reasons stated in the notice of deficiency for disallowance of

the interest expense deduction for 1986 remain in dispute.

B. Analysis

After the parties’ off-the-record conference described

above, counsel for petitioners stated on the record that he

believed the parties’ agreement included all adjustments then

being considered by the Court and invited counsel for

respondent’s position on that assertion. Counsel for respondent

did not point out any qualifications, restrictions, or exceptions

to any of the adjustments as to which the issues had been

narrowed. On brief, respondent takes the position the issues

were not narrowed with respect to petitioners’ 1986 interest

expense deduction, nor was any agreement reached with respect to

that issue.
 -373-

On this record, we conclude petitioners’ 1986 interest

expense deduction was included in (but inadvertently omitted

from) the agreement of counsel narrowing the issues to be decided

by the Court. Bearing in mind that these cases were very

complicated, involving numerous issues covering several tax years

of several taxpayers, it is easy to understand how one adjustment

could easily have been overlooked in counsel’s announcement to

the Court that the parties had agreed to narrow the issues in

dispute. Moreover, respondent failed to qualify or take any

exception to petitioners’ counsel’s representations to the Court

regarding the scope of their agreement.

Thus, we are left only with the question whether the funds

from the TACI and PSAC accounts used to pay Kanter’s expenses

were Kanter’s funds. As previously discussed, the funds Kanter

held in the TACI and PSAC accounts were his funds or funds he

borrowed from other TACI or PSAC clients. Accordingly, the

Kanters are entitled the interest expense deduction they claimed

for 1986.
 -374-

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

FINDINGS OF FACT

During the 1970s, Kanter was involved in a series of real

estate development projects with developers Sam Zell (Zell) and

Robert Lurie (Lurie). Kanter, Transcr. at 4241-4243, 4261. The

development properties were owned by partnerships (real estate

partnerships) and Kanter held interests in the real estate

partnerships through the BWK Revocable Trust, the Everglades

Trusts (Nos. 1-5), the BWK Family Trusts, and THC. Exh. 9156,

items 3, 6. The BWK Revocable Trust and the Everglades Trusts

were grantor trusts whose income was attributable to Kanter

personally. Exhs. 130 and 130A; Kanter, Transcr. at 4235, 4261-

4262.

The designated beneficiaries of the BWK Revocable Trust, the

BWK Family Trusts, and the Everglades Trusts were members of

Kanter’s family. Exhs. 453, 583, 9213, 130, 130A; Kanter,

Transcr. at 4235, 4261-4262. During 1983, THC’s shareholders

149
The STJ report recommended holding that respondent is
barred from making any determination concerning the taxable year
1983 on account of the expiration of the period of limitations
governing assessment and collection for that year. As previously
discussed, we determined that Kanter’s income tax returns for the
years at issue were fraudulent, and, therefore, the period of
limitations remains open pursuant to sec. 6501(c)(1).
 -375-

included Kanter, his immediate family members, and a large number

of Kanter family trusts. Exh. 152, at 1, 2, 6, 7; Exh. 454.

Weisgal was THC’s president. Exh. 9156, item 3.

Kanter’s interests in the real estate partnerships are

identified below by the entity which held each interest, the

partnership, and the entity’s percentage interest in the

partnership at the beginning of 1983:
 -376-

Percentage
Entity Partnership Interest

BWK Revocable Trust Diversified River Bend 18.60
BWK Revocable Trust Diversified Stephenson’s 8.44
BWK Revocable Trust Bajomonte Associates 27.33
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
Everglades Trusts 1-5 Cedar Cove Partners 8.71
Everglades Trusts 1-5 Diversified Boot Lake 8.706
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 8.825
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 Company 8.00
Everglades Trusts 1-5 Diversified Hillsborough 8.27
Everglades Trusts 1-5 Midwest Properties Group 8.44
Everglades Trusts 1-5 Washtenaw Management Co. 8.17
Everglades Trusts 1-5 Tradewinds Shopping Ctr. 5.88
BWK Family Trusts Centennial Investors 17.02
THC River Bend Investors 3.40
THC C & W Investors 30.00
THC First Commitment & Dev. 42.50
THC 332 Equity Partnership 18.75
THC Katy Land Company 16.67

Exh. 9156, Index and item 6. The River Bend Investors

partnership interest held by THC was previously held by the Bea

Ritch Trusts and was transferred to THC on or about January 1,

1983. Exh. 146, AJE’s 26 and 27.

During 1982, Zell informed Kanter that Equity Financial

Management Co. (Equity), an entity Zell controlled, was
 -377-

interested in purchasing all of the real estate partnership

interests listed above. Kanter, Transcr. at 4242-4244, 4253-

4254, 4265, 4302-4303. Although Kanter was interested in selling

the partnership interests, he was concerned the transaction would

trigger significant capital gains because his grantor trusts had

negative capital accounts in the real estate partnership

interests; i.e., their liabilities exceeded their bases. Kanter,

Transcr. at 4244. Kanter’s grantor trusts’ negative capital

accounts for the partnership interests in question, as of May 15,

1983, totaled $476,888.60, as follows:
 -378-

Entity Partnership/Interest Cap. Acct.

BWK Rev. Trust Bajomonte Associates (180,270.00)
BWK Rev. Trust Diversified River Bend (37,622.05)
BWK Rev. Trust Diversified Stephenson’s (30,364.70)
Everglades Trusts Wayside Partners (4,806.00)
Everglades Trusts Shady Crest Investors (36,425.79)
Everglades Trusts Diversified Raintree (27,005.92)
Everglades Trusts Cedar Cove Partners (40,725.89)
Everglades Trusts Diversified Boot Lake (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 Worthman Office Mall (12,751.50)
Everglades Trusts Kon-Tiki Apartments (25,606.66)
Everglades Trusts Diversified Hillsborough 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 Properties Group 13,834.56
Everglades Trusts Washtenaw Management Co. 2,766.09
Everglades Trusts Tradewinds Shopping Ctr. 3,107.00
Net capital accounts (476,888.60)

Exh. 142 (Sch. 7); Exh. 9166; Kanter, Transcr. at 4267, 4300-

4302.

As of mid-1983, the fair market value of the real estate

partnership interests Zell was interested in purchasing totaled

$1,219,321.64, as follows:
 -379-

Entity Partnership/Interest Price (FMV)

BWK Rev Trust Bajomonte Associates
BWK Rev Trust Diversified River Bend
BWK Rev Trust Diversified Stephenson's

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 Worthman 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 Properties
Everglades Trusts Washtenaw Management Co.
Everglades Trusts Tradewinds Shopping Ctr.

Total FMV--Everglades Trust $657,000.00

Entity Partnership/Interest Price (FMV)

BWK Family Trusts Centennial Investors $30,000.00

Entity Partnership/Interest Price (FMV)

The Holding Co. River Bend Investors
 -380-

The Holding Co. C & W Investors
The Holding Co. First Commitment & Dev.
The Holding Co. 332 Equity Partnership
The Holding Co. Katy Land Company

Total FMV--The Holding Co. $520,000.00

Exh. 9166.

Because an unqualified transfer of the partnership interests

of the grantor trusts to Zell would involve the assumption of

liabilities in excess of the trusts’ bases in the partnership

interests, Kanter (the owner of those interests by virtue of the

grantor trust provisions (sections 671-677) would be required to

recognize capital gains on the sale to Zell. In an effort to

avoid this result, Kanter directed a series of transactions in

1983 which ultimately resulted in the transfer of both cash and

the real estate partnership interests from his grantor trusts to

Zell. The transfers took place in three stages described below.

A. Transfer of Real Estate Partnership Interests to Cashmere

Cashmere Investments Associates, Inc. (Cashmere), was an

inactive “shelf” corporation incorporated in Delaware in 1982 and

controlled by Kanter. Exh. 9156; Kanter, Transcr. at 4231-4246,

4249, 4260-4261, 4266. Cashmere’s board of directors consisted

of Sharon Meyers and Weisgal. Exh. 9156, items 4, 10(g); Kanter,

Transcr. at 4264-4265. Weisgal was Cashmere’s president, Sharon
 -381-

Bayers was secretary, and Meyers was treasurer. Exh. 9156, item

4, at 2; Kanter, Transcr. at 4265.

On or about May 15, 1983, Kanter directed the transfer of

the grantor trusts’ real estate partnership interests to Cashmere

in what was intended to be a nontaxable exchange under section

351 in return for Cashmere common and preferred stock. Exh.

9156; Kanter, Transcr. at 4234-4245. THC, the BWK Family Trusts,

and the grantor trusts received Cashmere stock in exchange for

the real estate partnership interests as follows:

Shares of Stock
Shareholder Common Class A Preferred

BWK Revocable Trust 50 241.274
Everglades Trusts 400 257.226
BWK Family Trusts 30 --
THC 520 --

Exh. 9156, items 3, 5, 6.

Concurrently with the transfers described above, Kanter’s

grantor trusts also transferred to Cashmere eight promissory

notes with an aggregate face value of $498,500. Exh. 9156, item

7; Kanter, Transcr. at 4235-4238, 4244, 4249, 4267-4268.

Kanter’s grantor trusts transferred the following notes

receivable to Cashmere:
 -382-

Maker Payee Amount

THC Everglades Trusts $90,000
Burton W. Kanter Everglades Trusts 34,230
Beach Trust Burton W. Kanter 128,725
HELO Everglades Trusts 94,800
GL’s Associates Everglades Trusts 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

Exh. 9156, index and item 7; Kanter, Transcr. at 4269-4270. Each

promissory note listed above was dated May 1, 1983, and was due

and payable on August 31, 1983. Respondent’s Opening Brief at

1024, par. 1538; Petitioners’ Reply Brief at 1348.

The trustee of Beach Trust was Albert Morrison, the grantor

was Kanter, and the beneficiaries were members of Kanter’s

family. Exh. 9216. The trustee of the Baroque Trusts was

Patricia Grogan, the grantor was Kanter, and the beneficiaries

were members of Kanter’s family. Exh. 9219. For Federal tax

purposes, Kanter was the “deemed owner” of the Baroque Trusts,

and income therefrom generally was reportable on Kanter’s

individual Federal income tax returns. Exh. 9111, Bates Nos.

000125-000127.

Kanter intended that, if the promissory notes were accorded

bases equal to face values, the promissory notes would increase

the aggregate basis of the property the grantor trusts

transferred to Cashmere; i.e, the promissory notes’ bases would
 -383-

offset the grantor trusts’ negative capital accounts in the real

estate partnership interests, thereby eliminating the gain that

otherwise would have been realized under section 357(c) if

Cashmere had received the real estate partnership interests

alone.150 Kanter did not, however, present any evidence to

establish the genuineness of the promissory notes.

B. Sale of Cashmere Stock to Waco

Waco Capital Co. (Waco) was a corporation organized under

the laws of the State of Delaware, Meyers was its president, and

the Bea Ritch Trusts were its sole shareholders. Exh. 9156,

items 8, 10(b), (c), (f); Kanter, Transcr. at 4270. The Bea

Ritch Trusts’ beneficiaries were members of Kanter’s family and

who were also the beneficiaries of Kanter’s grantor trusts. Waco

150
Sec. 357(c) provides in pertinent part:

SEC. 357 (c). Liabilities in Excess of Basis.--

(1) In general.--In the case of an exchange--

(A) to which section 351 applies * * *

if the sum of the amount of the liabilities
assumed * * * exceeds the total of the adjusted
basis of the property transferred pursuant to
such exchange, then such excess shall be
considered as a gain from the sale or exchange of
a capital asset or of property which is not a
capital asset, as the case may be.
 -384-

later changed its name to Windy City, Inc. Kanter, Transcr. at

4536.151

On July 12, 1983, the BWK Revocable Trust, the Everglades

Trusts, THC, and the BWK Family Trusts sold all of their Cashmere

stock (common and preferred shares) to Waco for promissory

installment notes totaling approximately $1.5 million. Exh.

9156, items 8, 9. The Waco promissory notes provided for

payments in 1983 and 1984 and balloon payments in 1993. Id. The

Waco promissory notes were secured by the Cashmere stock, subject

to Waco’s option to substitute as collateral the guaranties of

its shareholders, the Bea Ritch Trusts, which would pledge

various partnership interests (known in the aggregate as

“Cablevision”). Exh. 9156, item 7, at 3. Sharon Meyers, on

behalf of Waco and the Bea Ritch Trusts, subsequently exercised

this option to substitute collateral. Exh. 9156, item 46.

Kanter reported installment sale income on Forms 6252

attached to his Federal income tax returns for 1984 and 1985.

Exhs. 130, 130A. Kanter did not present any evidence to

151
As previously mentioned supra p. 176, Zeus purchased
Waco/Windy City, Inc. stock in 1986. In addition, Kanter sold to
Windy City certain promissory notes, bonds, and shares of stock
in a failed attempt to generate capital losses for 1987. See
Issue XXIII, infra.
 -385-

establish that WACO actually made any payments in connection with

the installment promissory notes described above.

On August 25, 1983, Kanter wrote a letter to Lurie which

stated that Cashmere’s stockholders (at this point Waco and/or

the Bea Ritch Trusts) decided they would approve a sale of 100

percent of Cashmere’s stock to Equity only in exchange for cash.

Exh. 9157. The letter also stated Cashmere held only real estate

partnership interests and promissory notes “all of which will be

paid down by August 31, 1983.” Id.

On August 31, 1983, the promissory notes held by Cashmere

were paid off by checks drawn on the TACI Special E account, as

follows:

Ck. No. Date Payee Amount

1315 8/31/83 Holding Company $90,000
“For BRT”
1316 8/31/83 BWK Revocable Trust 34,230
“For BRT”
1317 8/31/83 Beach Trust 128,725
“For Trust (BRT)”
1318 8/31/83 Cashmere 94,800
“For HELO”
1319 8/31/83 Cashmere 38,000
“For GLS Assoc”
1320 8/31/83 Cashmere 25,045
“For ARO”
1321 8/31/83 Cashmere 66,000
“For Baroque Tr.”
1322 8/31/83 Cashmere 21,700
“For BWK Childrens Tr.”
Total 498,500
 -386-

Exhs. 9159, 9160, 9161, and 9162; Kanter, Transcr. at 4276-4278,

4284-4285, 4288-4289, 4292. Check Nos. 1315 to 1317, listed

above, were not made out to Cashmere because the debtors on those

notes (Beach Trust, BWK Revocable Trust, and THC) were instructed

to transmit their own checks to Cashmere. Exh. 9158 (Beach

Trust); Exh. 148, at 8, 13 (THC); Kanter, Transcr. at 4274-4275,

4284-4286. Kanter testified that TACI transferred to Beach

Trust, BWK Revocable Trust, and THC the amounts reflected in

check Nos. 1315 to 1317 above), the amounts so transferred were

considered loans from the Bea Ritch Trusts, and those loans were

paid back. Kanter, Transcr. at 4292-4294. However, no

documentary evidence (promissory notes, payment schedules,

canceled checks representing interest or principal payments, or

other records) was presented at trial to substantiate Kanter’s

testimony.

As of September 1, 1983, Waco held all of Cashmere’s

outstanding stock, and Cashmere’s assets included the real estate

partnership interests and $498,500 in cash. Exh. 9156, Item

10(a), at 5.

C. Sale of Cashmere Stock From Waco to Zell

On September 2, 1983, Kanter negotiated the sale of Waco’s

Cashmere stock to Equity in exchange for a check in the amount of

$1,647,500. Exh. 9156, items 10A, 52; Kanter, Transcr. at 4250-
 -387-

4251, 4259, 4263. Because Cashmere held cash in the amount of

$498,500, $1,149,000 of the purchase price was allocable to the

partnership interests that Zell was interested in acquiring.

Exh. 9156, items 10(A); Exhs. 9157, 9164.

Zell was not interested in the Cashmere stock and would have

preferred to buy the partnership interests outright, but this was

the only way that Kanter would permit the sale. Exh. 9157;

Kanter, Transcr. at 4250, 4252-4253.

OPINION

A. The Parties’ Arguments

Respondent determined that Kanter received a net long-term

capital gain of $190,756 as a result of the transfers from his

grantor trusts to Cashmere. The notice of deficiency stated in

pertinent part: “It is determined that your grantor trusts had a

zero basis and negative capital account of $476,889 in the

partnership interests transferred. The transfer of other assets

to the corporation by the trusts has no bona fide business

purpose, was made only to avoid income tax, and, thus is ignored

for Federal income tax purposes.” Respondent further determined

that Kanter received a net long-term capital gain of $378,800 as

a result of his grantor trusts’ sale of Cashmere stock to Waco.

The notice of deficiency stated in pertinent part:

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
 -388-

(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.

On brief, respondent asserts the transfers from Kanter’s

grantor trusts to Cashmere do not qualify for nonrecognition

treatment under section 351 on the alternative grounds that (1)

there was no valid business purpose for the transfers from the

grantor trusts to Cashmere and/or the grantor trusts did not

control Cashmere immediately after the transfer (under the step-

transaction doctrine), (2) the principal purpose for the

transfers from the grantor trusts to Cashmere was the avoidance

of Federal income tax under section 357(b), and (3) the

promissory notes that the grantor trusts transferred to Cashmere

did not represent genuine indebtedness, and therefore Cashmere

assumed liabilities in excess of the bases in the partnership

interests it received within the meaning of section 357(c).

Respondent also avers that Waco’s purchase of Cashmere’s stock

did not qualify for installment sale treatment because the

transaction amounted to a disposition “of property to a related

person” within the meaning of section 453(e)(1)(A).

Kanter argues the question whether the Cashmere transaction

qualifies for nonrecognition treatment under section 351 is not

properly before the Court, and, in any event, the grantor trusts

transferred their partnership interests to Cashmere for
 -389-

legitimate business purposes; i.e., to enjoy tax advantages in

the event the partnership interests were sold and/or to “have an

aggregation of value” within the corporate entity to allow for

more efficient investments. Kanter, Transcr. at 4243. Kanter

further asserts the section 357(b) issue was not raised in the

pleadings and is not properly before the Court and, in any event,

the Cashmere transaction is not the type of arrangement that

section 357(b) is designed to address. Finally, Kanter contends

the promissory notes the grantor trusts transferred to Cashmere

constituted genuine indebtedness, rendering section 357(c)

inapplicable in these cases.

B. Analysis

Respondent determined in the notice of deficiency that the

transfers from Kanter’s grantor trusts to Cashmere for stock did

not qualify as a tax-free exchange because the transfers were not

intended to serve a bona fide business purpose but instead were

carried out only to avoid Federal income tax. Although the

notice of deficiency did not explicitly refer to section 351 or

357, we conclude Kanter understood respondent’s position

regarding the Cashmere transaction and the bases for respondent’s

adjustments. We further conclude, as discussed in detail below,

the Cashmere transaction does not qualify for nonrecognition

treatment under either section 357(b) or (c), and therefore we
 -390-

sustain respondent’s determination that Kanter realized a long-

term capital gain as a result of the Cashmere transaction.

A taxpayer generally recognizes gain or loss on a sale or

exchange of property. Sec. 1001(c). Section 351(a) provides an

exception to the general rule of section 1001(c), however, when a

taxpayer transfers an appreciated asset (such as a partnership

interest) to a controlled corporation solely in exchange for the

corporation’s stock. The favorable tax benefits associated with

section 351 are subject to several qualifying provisions outlined

below.

As a general rule, if a taxpayer receives property pursuant

to a section 351 exchange and, as part of the transaction,

another party to the transaction assumes a liability of the

taxpayer, the assumption of liability shall not be treated as the

receipt of money or property and shall not disqualify the

transaction for nonrecognition treatment under section 351. Sec.

357(a). The general rule of section 357(a) is subject to the two

exceptions set forth in section 357(b) and (c).

To paraphrase, section 357(b) provides that an assumption of

a taxpayer’s liability under section 357(a) shall be considered

money received by the taxpayer for purposes of section 351 if,

taking into consideration the nature of the liability and the

circumstances surrounding the arrangement, it appears the
 -391-

taxpayer’s principal purpose was to avoid Federal income tax on

the exchange or was not a bona fide business purpose.

Section 357(c)(1)(A) provides, in the case of an exchange to

which section 351 applies, that if the amount of the liabilities

assumed exceeds the total of the adjusted basis of the property

transferred pursuant to the exchange, the excess is treated as

gain from the sale of a capital or noncapital asset, as the case

may be.152

1. Applicability of Section 357(b)(1)

Considering all the facts and circumstances, we conclude

Kanter arranged the Cashmere transaction principally for the

purpose of avoiding Federal income tax. The convoluted series of

Cashmere transactions began when Zell informed Kanter of Equity’s

desire to acquire the partnership interests held by Kanter’s

grantor trusts. In the end, Equity acquired those partnership

interests in exchange for cash. In between, over a period of a

few months, Kanter arranged: (1) Transfers of notes receivable

to his grantor trusts in an aggregate amount approximately equal

to the grantor trusts’ negative capital accounts in their

partnership interests, (2) transfers of the grantor trusts’

partnership interests and the notes receivable to Cashmere in

exchange for Cashmere stock, (3) sales by the grantor trusts of

their Cashmere stock to Waco for promissory notes, (4) the

152
Sec. 357(c)(2)(A) provides sec. 357(c)(1) shall not
apply to any exchange to which sec. 357(b)(1) applies.
 -392-

purported satisfaction of the notes receivable held by Cashmere,

and, finally, (5) Waco’s sale of Cashmere stock to Equity.

Considering Zell simply wanted to acquire the real estate

partnership interests held by Kanter’s grantor trusts, and taking

into account Kanter’s desire to avoid recognizing gain on the

sale to Zell to the extent his grantor trusts had negative

capital accounts in the partnership interests, it is clear the

rapid series of transactions described above, particularly the

transfer of notes receivable to Cashmere, was carried out for no

reason other than to avoid Federal income tax. Moreover, Waco’s

promissory notes to Kanter’s grantor trusts ostensibly provided

additional tax benefits in that Kanter reported the gains

realized on the sale of Cashmere stock to Waco under the

installment method, even though Equity paid Waco in full in 1983.

In the absence of any showing that Cashmere served any legitimate

business purpose before or after the transactions described

above, we sustain respondent’s determination that the transfers

of the partnership interests with negative capital accounts to

Cashmere constitute money received by Kanter (through his grantor

trusts) and Kanter is taxed on the gain resulting from the

transfers up to the full amount of the assumed liabilities.

2. Applicability of Section 357(c)

Section 357(c)(1)(A) provides that, in the case of an

exchange to which section 351 applies, if the amount of the
 -393-

liabilities assumed exceeds the total of the adjusted basis of

the property transferred pursuant to the exchange, then the

excess is treated as gain from the sale of a capital or

noncapital asset, as the case may be. Considering all the

circumstances, we conclude, as an alternative to our analysis

under section 357(b), that the grantor trusts’ transfer of the

eight notes receivable to Cashmere is not entitled to be

respected for purposes of applying section 357(c).

Cashmere was, at best, a passive investment vehicle as

opposed to an operating business, and in this light the transfer

of the notes receivable to Cashmere served no business purpose

independent of the tax benefits Kanter hoped to reap. The eight

notes receivable in question (1) were either payable by Kanter

individually or by entities he controlled, (2) reflected a total

principal amount approximately equal to the aggregate negative

capital accounts of the partnership interests in question, (3)

were all dated May 1, 1983, and payable on August 31, 1983, and

(4) were all repaid with funds from a TACI account. There is no

discernible paper trail evidencing the source of the TACI funds.

In the end, the cash paid to Cashmere/Waco on the notes

receivable was returned to Kanter (indirectly) in the form of a

portion of the cash payment Equity made to Waco for Cashmere’s

stock.
 -394-

Considering all the circumstances, we conclude the notes

receivable were used as a device to circumvent section 357(c) and

resulted in nothing more than a circular transfer of funds

between and among Kanter-controlled entities. There is no

evidence in the record that the notes receivable represented

valid indebtedness.

In the absence of any discernible bases in the notes

receivable, we conclude the notes did not increase the aggregate

basis in the property Kanter’s grantor trusts transferred to

Cashmere. Under section 357(c), Kanter was required to recognize

as capital gain the excess of the liabilities Cashmere assumed

over basis in the property his grantor trusts transferred to

Cashmere.

3. Kanter’s Use of the Installment Method

Section 453(a) provides the general rule that income from an

installment sale shall be reported under the installment method.

An installment sale generally is defined as a disposition of

property where at least one payment is to be received after the

close of the taxable year in which the disposition occurs. Sec.

453(b)(1).

Section 453(e) prescribes special rules applicable to

installment sales by related persons. In particular, section

453(e)(1) provides that if a person sells property to a related

party (the first disposition) under the installment method, and
 -395-

the related party purchaser then resells the property (the second

disposition) within 2 years after the first disposition and

before the original seller has received all payments due with

respect to the first disposition, the amount realized by the

related party on the second disposition is treated as a payment

received at that time by the original seller. Section 453(e)(7)

provides that subsection (e) shall not apply to a second

disposition if neither the first disposition nor the second

disposition had as one of its principal purposes the avoidance of

Federal income tax.

Section 453(f)(1)(A) and (B) defines the term “related

person” for purposes of section 453(e) as a person whose stock

would be attributed under section 318(a) (other than paragraph

(4) thereof) to the person first disposing of the property or a

person who bears a relationship described in section 267(b) to

the person first disposing of the property.

Waco’s stock was owned entirely by the Bea Ritch Trusts, and

the beneficiaries of the Bea Ritch Trusts were members of

Kanter’s family. In addition, Kanter’s family members were the

beneficiaries of Kanter’s grantor trusts. Because the Waco stock

owned by the Bea Ritch Trusts is considered owned by the

beneficiaries of the Bea Ritch Trusts under section

318(a)(2)(B)(i), and those same beneficiaries are also the

beneficiaries of Kanter’s grantor trusts, ownership of the Waco
 -396-

stock is imputed to the grantor trusts under section

318(a)(3)(B)(i).153 It follows that the grantor trusts’ sale of

Cashmere stock to Waco constituted a sale to a related person for

purposes of section 453(f)(1)(A). When Waco subsequently, within

2 years, transferred the Cashmere stock to Equity before paying

the grantor trusts for the Cashmere stock, the installment method

of reporting was no longer available to the grantor trusts (and

Kanter) by virtue of section 453(e)(1). In sum, the entire

amount Waco realized upon its sale of Cashmere stock to Equity

(the second disposition) is treated as received by the grantor

trusts at the time of the second disposition. Thus, we sustain

respondent’s determination that Kanter was not eligible for

installment sale reporting.

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

In an amendment to answer, filed November 6, 1989,

respondent asserted the Kanters were liable for an increased

153
Alternatively, under Issue V supra, we concluded Kanter
was the grantor of the Bea Ritch Trusts under the grantor trust
provisions. Attributing the Waco stock held by the Bea Ritch
Trusts to Kanter, see sec. 318(a)(2)(B)(ii), it follows that
Kanter’s ownership of the Waco stock also is attributed to
Kanter’s grantor trusts under sec. 318(a)(3)(B)(ii). Thus, Waco
and the grantor trusts are considered related persons under sec.
453(f)(1)(A).
154
The Court’s disposition of this issue represents in
large measure a wholesale adoption of the recommended findings of
fact and conclusions of law set forth in the STJ report.
 -397-

deficiency for 1979 attributable to the disallowance of a loss

of $311,478 the Kanters claimed from Immunological Research Corp.

(IRC), an S corporation in which the Kanters held an interest

through grantor trusts (i.e., the Pillpoppers Trusts).

Respondent determined that IRC was not entitled to a research and

development expense of $980,000 or various other business

expenses it reported for 1979.

FINDINGS OF FACT

The facts underlying this issue were also considered by this

Court in Estate of Cook v. Commissioner, T.C. Memo. 1993-581,155

which involved another shareholder in IRC. In Estate of Cook,

the Court sustained the Commissioner’s disallowance of research

and experimentation expenses under section 174(a), as well as

similar expenses claimed by two other subchapter S corporations,

Antiviral Research Corp. (ARC) and Biological Research Corp.

(BRC), that were engaged in the same activity. Kanter was not a

stockholder in ARC or BRC. In the instant case, the parties

stipulated to the record of Estate of Cook except as to those

portions of the record relating to the other two subchapter S

corporations.

155
The decision the Court entered at docket No. 9533-87,
in accordance with its Memorandum Opinion in Estate of Cook v.
Commissioner, T.C. Memo. 1993-581, was not appealed and is final.
See secs. 7481(a)(1), 7483.
 -398-

Kanter was counsel of record for the taxpayers in Estate of

Cook and was the trial attorney before this Court. Since Kanter

was an investor in IRC, he had offered himself as a witness for

the taxpayers at the trial of the Estate of Cook case. The Court

did not allow Kanter to testify, however, because he was the

trial attorney for the taxpayers. In the instant cases, Kanter

was not the trial attorney and was before this Court as a party

litigant and, therefore, he was allowed to testify as a witness.

For present purposes, the Court recites the pertinent facts

from Estate of Cook. Kanter contends the Court’s holding in

Estate of Cook is in error. A more detailed and comprehensive

findings of fact can be found in the reported opinion of Estate

of Cook.

During 1979, Kanter and three other individuals (including

George Cook, whose estate was the taxpayer in Estate of Cook,

invested in IRC. None of the stockholders in IRC, including

Kanter, had any formal educational background or experience in

the field of pharmaceutical compounds, which was the business IRC

was set to engage in.

Shortly after IRC was organized, IRC entered into a

research/licensing agreement with Newport Pharmaceutical

International, Inc. (Newport). Newport was then engaged in the

manufacture, marketing, research, and development of

pharmaceutical compounds. Newport owned an undivided one-half
 -399-

interest in a compound identified as the NPT-15000 series that it

had acquired in 1978 from the Sloan-Kettering Memorial Institute

for Cancer Research (Sloan-Kettering), the discoverer of the

compound. At that time, this particular compound was still in

the experimental stage of development.

In the 1978 transaction, Newport also acquired one-half of

the “Patent Rights [of the compound], and the inventions and

improvements covered thereby, throughout the world.” The term

“Patent Rights” was comprehensively defined elsewhere in the 1978

sales agreement. In this 1978 sales agreement, Newport was given

the exclusive right to exploit the patent rights to the subject

compound on a world-wide basis, as to which Newport agreed to use

its best efforts to exploit the patent rights for the mutual

benefit of itself and Sloan-Kettering. The agreement further

allowed Newport to license third parties in connection with the

exploitation of the subject compound; however, such licensing

agreements, among other things, had to be agreed to by

Sloan-Kettering.

IRC ostensibly was organized to engage in a licensing

agreement with Newport for exploitation of the NPT-15000 series

compound in which Newport held a one-half interest. IRC and

Newport entered into such an agreement in 1979 for the compound

identified as NPT-15392, which was within the NPT-15000 series.

However, the licensing agreement IRC entered into was only with
 -400-

Newport. Sloan-Kettering was not a party to the agreement, did

not sign the agreement, and there is no evidence that

Sloan-Kettering ever acquiesced in the agreement. Newport and

IRC were cognizant of Sloan-Kettering’s patent reservation

rights, and, accordingly, the licensing agreement between IRC and

Newport was structured or attempted to be structured in such

fashion that the exploitation of the subject compound by IRC or

its licensees would not violate Sloan-Kettering’s rights. With

that end in mind, the research agreement between IRC and Newport

contained the following provision:

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 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 their 1979 Federal income tax return, as noted

earlier, the Kanters claimed a deduction for their portion of

this $980,000 research and experimentation expense, which
 -401-

respondent disallowed, consistent with the Commissioner’s

position in Estate of Cook v. Commissioner, T.C. Memo. 1993-581.

In Estate of Cook, this Court sustained the Commissioner’s

determination disallowing the portion of the $980,000 expense

claimed by George Cook as a deduction under section 174(a). The

parties agreed in the Estate of Cook case that IRC was not

engaged in a trade or business within the meaning of section

162(a). The Kanters here do not contend otherwise. The Kanters

contend, however, as Kanter argued for the taxpayers in the

Estate of Cook case, that the expense nevertheless qualified as a

deduction under section 174(a) as a research or experimentation

expense.

This Court, in the Estate of Cook case, held the expense was

not a research or experimentation expense within the meaning of

section 174(a) based on the premise that, to qualify under

section 174(a), two requirements must be satisfied: (1) The

taxpayer must have an objective intent to enter into the trade or

business envisioned by the licensing agreement, and (2) the

taxpayer must demonstrate the capability to engage in such trade

or business. The Court went on to conclude that IRC failed to

meet both of these tests. Of significance to the Court was the

fact that the taxpayers had not established that IRC had obtained

any ownership rights in any technology to be developed by Newport

because Sloan-Kettering was not a party to and had not consented
 -402-

to the licensing agreement (as required in the 1978 sale by

Sloan-Kettering to Newport), and, moreover, the license agreement

between Newport and IRC expressly provided that no ownership

rights in the technology to be developed by Newport would inure

to IRC to the extent that such technology or rights envisioned by

the agreement came within the definition of “Patent Rights” as

reserved by Sloan-Kettering in the 1978 sale to Newport. The

reservation by Sloan-Kettering in the 1978 sale to Newport

provided:

[the third-party license] shall have no ownership right 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 dated March 28, 1978 between Newport and Sloan-
Kettering Institute or is covered by the Assignment
Agreement between Newport and Paul Gordon dated April 26,
1971 (collectively the “Prior Agreements”).

In light of the reservation in the 1978 sale by Sloan-Kettering

to Newport and the broad definition of “Patent Rights” in the

same instrument, this Court concluded little, if anything, was

left to be acquired by IRC in the 1979 licensing agreement

between Newport and IRC.156 The Court stated: “In light of this

156
The Mar. 28, 1978, agreement wherein Sloan-Kettering
conveyed a one-half interest to Newport defined “patent right” as
follows:
a. Any U.S. patent application hereafter filed
covering any invention or improvement resulting from
the Collaborative Efforts, and division, continuation,
and continuation-in-part of any such application, and
any patent which shall issue based on such application,
(continued...)
 -403-

definition, it is hard to visualize that [IRC] obtained ownership

156
(...continued)
division, continuation, and continuation-in-part.
b. Any patent which is a reissue or an extension
of, a patent of addition to, any patent defined in (a)
above;
c. Any patent application or patent corresponding
to any patent application or patent identified in (a)
or (b) above which is hereafter filed or issued in any
country.

In the licensing agreement between Newport and IRC, entered into
in 1979, the research to be undertaken by Newport was described
as follows:

The research which is the subject of this Agreement
will include, but is not limited to the areas of:
chemical synthesis and analysis of compounds to be
agreed upon; research and development of pharmaceutical
dosage forms and methods of quality control testing for
identity, purity and stability; preclinical
toxicological, pharmacological and biochemical studies
in tissue culture and animal models to determine safety
efficacy and method of action and to provide guidelines
for the investigation of potential applicability to
human subjects; toxicological, pharmacological and
biochemical studies in human subjects to determine
safety and degree of tolerance in man; and clinical
trials to determine range of clinical potential and
conditions for obtaining maximum therapeutic benefit at
minimum risk in clinical usage.

This shall be a fixed price contract and Newport will
provide to * * * [IRC] data on NPT-15392 and such other
substances as may be agreed to, establishing the acute
toxicity (single dose administration to two species);
subacute toxicity (multiple dose administration in two
species for 90 days); single dose administration to
humans designed to establish the level at which the
drug may be safely administered (including laboratory
and physical measurements of potential side effects)
and the results of efficacy testing in at least 12
patients in which laboratory parameters of the immune
response are measured.
 -404-

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 be owned by

IRC.

There were other facts the Court discussed to support the

conclusion IRC was not engaged in a trade or business and did not

have the capability to engage in a trade or business. These

other findings are not seriously challenged by Kanter in the

instant cases, and the Court does not consider it necessary to

discuss those factors here.

Kanter was the only witness for petitioners with respect to

this issue. No documentary evidence was presented to corroborate

Kanter’s testimony. Kanter’s testimony was directed toward

establishing that there were certain rights or the ownership of

technology that IRC could acquire from the licensing agreement

with Newport that would not fall within the umbrella of the

“Patent Rights” exception existing in favor of Sloan-Kettering.

OPINION

A. Trade or Business Requirement of Section 174

Section 174(a)(1) provides:

A taxpayer may treat research or experimental
expenditures which are paid or incurred by him during
the taxable year in connection with his trade or
business as expenses which are not chargeable to
 -405-

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. Sec. 1.174-2(a)(8), Income Tax

Regs.

To be entitled to deductions for research and experimental

expenditures, a taxpayer is not required to currently produce or

sell any product. Moreover, a taxpayer need not be currently

engaged in a trade or business in order to qualify for such

deductions. Snow v. Commissioner, 416 U.S. 500, 503-504 (1974).

Nevertheless, in Green v. Commissioner, 83 T.C. 667, 686-687

(1984), the Court stated:

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. 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 claiming deductions under section 174, the
 -406-

relevant inquiry is whether the entity has any realistic prospect

of entering into a trade or business involving the technology

under development. 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).157

As the foregoing cases demonstrate, when an entity contracts

out the performance of the research and development in which it

intends to engage, all of the surrounding facts and circumstances

are relevant to the inquiry whether the entity has any realistic

prospect of entering into a trade or business with respect to the

technology under development. Consideration is given to (1) the

intentions of the parties to the contract for the performance of

the research and development, (2) the amount of capitalization

retained by the entity during the research and development

contract period, (3) the exercise of control by the entity over

the person or organization doing the research, (4) the existence

of an option to acquire the technology developed by

the organization conducting the research and the likelihood of

its exercise, (5) the business activities of the entity during

the period in question, and (6) the experience of the investors

in the entity. Absent a realistic prospect that the entity will

157
See also Double Bar Chain Co., Ltd. v. Commissioner,
T.C. Memo. 1991-572; Coleman v. Commissioner, T.C. Memo.
1990-357.
 -407-

enter a trade or business with respect to the technology, the

entity will be treated as a passive investor, not eligible for

deductions under section 174.

As indicated previously, in Estate of Cook v. Commissioner,

T.C. Memo. 1993-581, the Court addressed another IRC

shareholder’s entitlement to a deduction for IRC’s claimed 1979

research and development expense. In Estate of Cook, the Court

rejected the taxpayers’ contention that a realistic prospect

existed of IRC’s entering into a trade or business to exploit the

results of the research and experimentation it acquired from

Newport.

B. The Parties’ Arguments

Because respondent raised this issue in an amendment to

answer in which he asserted an increased deficiency, respondent

has the burden of proof on this issue under Rule 142(a)(1).

Respondent asserts the identical research and development expense

and business expense issues were presented to and decided by the

Court in Estate of Cook, and respondent maintains the Court’s

reasoning and conclusions in Estate of Cook are equally

applicable here.

Petitioners contend the issues are purely factual and the

present cases can be distinguished from the Estate of Cook case

on the grounds that (1) Respondent, not petitioners, bears the

burden of proof; and (2) Kanter was permitted to testify in these
 -408-

cases. Petitioners argue that the Court’s conclusions here with

respect to IRC should not be based upon certain “irrelevant”

facts concerning Antiviral Research Corp. (ARC) and Biological

Research Corp. (BRC), as petitioners imply happened in Estate of

Cook. Petitioners maintain that almost all of the facts

concerning ARC and BRC that were discussed in the Estate of Cook

opinion are irrelevant here because (1) Kanter was not a

shareholder of either ARC or BRC, and (2) all events relating to

ARC and BRC occurred after 1979. In particular, petitioners

assert that much of the documentation cited and relied upon by

respondent in respondent’s proposed findings of fact is not

actually in evidence in the instant cases, in the light of

petitioners’ specific exclusion in the parties’ written

stipulation of those portions of the Estate of Cook record

regarding ARC and BRC.

C. Analysis

Preliminarily, the Court notes that the parties, for

purposes of the instant cases, generally stipulated the Estate of

Cook record, except for evidence that related only to ARC or BRC.

Thus, as the Court interprets the parties’ stipulation, the

evidence presented in Estate of Cook on ARC and BRC that would be

relevant to IRC (not including perhaps the testimony of Dr.

Charles Altschuler, which the Court, in any event, hereinafter

does not rely upon) would be considered as evidence in the
 -409-

instant cases and could be considered in resolving the IRC issues

for 1979. The Court does not construe the parties’ stipulation

to limit the evidence here to only those portions of the Estate

of Cook evidentiary record that petitioners, in their sole

opinion, considered “relevant” to IRC and Kanter.

On this record, respondent has established that Kanter is

not entitled to deduct research and development expenses for 1979

under section 174(a). The evidence establishes that there was no

realistic prospect of IRC’s entering into a trade or business to

exploit the technology relating to the NPT-15392 compound being

developed under the IRC-Newport research/licensing agreement.

Simply put, there was little, if anything, IRC could acquire from

the deal since virtually anything that Newport developed would

almost certainly be a patentable property right that could not be

owned by IRC.

As this Court previously noted in Estate of Cook v.

Commissioner, T.C. Memo. 1993-581: (1) The broad definition of

the term “patent rights”, as defined in the March 28, 1978,

agreement between Newport and Sloan-Kettering, made it virtually

impossible for IRC to acquire ownership of anything that could be

commercially exploited in a trade or business; (2) the existence

of the IRC Shareholders-Newport put/call agreement made it

extremely unlikely IRC would ever be able to use, in a trade or

business, the research Newport conducted because (a) if the
 -410-

research were sufficiently successful to require the payment of

royalties, then Newport likely would exercise its call option

allowing it to buy the IRC stock and, (b) if the research were

not sufficiently successful to require the payment of royalties,

then IRC’s shareholders would be motivated to put their IRC

shares to Newport in return for Newport common stock; (3) after

its initial capital was expended, IRC had no further capital to

conduct or finance further research, and the existence of the put

and call agreements gave IRC’s shareholders no incentive to

contribute additional capital to IRC; and (4) some of IRC’s

shareholders apparently had always wanted to acquire Newport

stock, and structuring such an investment as a research and

development activity would allow the investors a deduction for

their investment.

Although the record in these cases includes Kanter’s

testimony, testimony which was not allowed in the Estate of Cook

case, the Court finds Kanter’s testimony unconvincing. Kanter’s

testimony was in the nature of advocacy as opposed to a

presentation of substantive evidence that would show that the

conclusions of the Court in Estate of Cook were in error, or that

essential and relevant facts had not been presented to the Court

in Estate of Cook. Essentially, Kanter misunderstood this

Court’s reasoning in Estate of Cook. Kanter argued that the

Court in Estate of Cook incorrectly assumed that IRC held no
 -411-

technical legal ownership rights in the know-how produced under

the research project. Kanter contended that IRC did hold “other

valuable rights” in the research know-how outside of any existing

and derivative future “patent rights” in the NPT-15000 series of

compounds retained by Newport and Sloan-Kettering.158 However,

158
Kanter testified as follows:

[Kanter]: Well, I can’t speak to it, Your Honor,
in terms of being a patent attorney, and I don't
profess to necessarily understand what a patent
attorney would testify to as an expert, but it was my
understanding that the documents here [i.e., the
IRC-Newport R&D and License Agreement and the March 28,
1978, agreement between Newport and Sloan-Kettering],
which are part and parcel of the manner in which the *
* * [Court] developed its opinion in Cook, involved
patent rights as a form of rights that belonged to * *
* (Newport] and Sloan-Kettering under the documents.

The other rights [belonging to IRC] would be
those, of course, that exist if no patent rights were
obtained, and any other rights that were not
encompassed by any patent rights that were defined, so
that there was a body of rights that could be available
to IRC.

Absent Newport * * * and Sloan-Kettering
undertaking something that would preclude a given
right, if they were granted such a right, IRC had the
basic rights it could proceed with, should a product be
developed from this particular research.

The Court: So I guess what you are saying is, * *
* that the researcher really has * * * [retained the
rights to develop the technology]

* * * * *

[Kanter]: Right. And I think that is one of the
things they do go on, and the Court, in * * * [Estate
of Cook], pointed to the fact that Newport,.and
Sloan-Kettering appeared, under the definition of
(continued...)
 -412-

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 [Estate of 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
to another stage to bring it to a commercial product
that will be put on the shelf.

158
(...continued)
patent rights, to own the rights, and that IRC owned no
rights.

* * * * *

[Petitioners' counsel]: Well, in fact, isn’t it
true, Mr. Kanter, that unless a patent was obtained or
reissued, that all rights would have remained in IRC?

[Kanter]: That is my understanding.

Kanter, Transcr. at 4851-4854.
 -413-

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 commercially manufactured.
* * * [Emphasis added.]

The Court: But there have been no development 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. [Kanter, Transcr. at 4853-4854.]

The mystery to the Court is just what those “rights” might

be. The Court is quite skeptical that, in the everyday world, an

investor would pay $980,000 for a bundle of ambiguous property

rights when there is no indication that the rights could be

exploited or developed. Moreover, this Court’s holding in Estate

of Cook was not premised totally or exclusively upon IRC’s

holding no technical legal ownership rights whatsoever in the

research, as Kanter implies. Rather, in Estate of Cook, this

Court concluded, after considering the totality of the attendant

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.159

159
Other factors considered by the Court included a
put/call agreement that allowed the IRC shareholders to “put”
their stock in IRC to Newport, which the stockholders of IRC
(continued...)
 -414-

Indeed, in his testimony, Kanter could not elaborate or

describe what realistic prospects IRC would have of exploiting

commercially the technology being developed. In view of the

broad scope of the existing and potential patent rights Newport

and Sloan-Kettering held, it is difficult to believe that a third

party, such as a major pharmaceutical company, would want to

license from IRC the know-how on NPT-15392 to further develop

that technology.

On the basis of the foregoing, the Court holds the Kanters

are not entitled to a deduction under section 174 for 1979 with

respect to IRC’s claimed research and development expense. See

Spellman v. Commissioner, 845 F.2d 148 (7th Cir. 1988), affg.

T.C. Memo. 1986-403; Diamond v. Commissioner, 92 T.C. 423 (1989),

159
(...continued)
would likely exercise if the research turned sour, or the “call”
agreement that allowed Newport to buy the IRC stock, which likely
would occur if the development of the technology proved to be
successful. The Court also noted that all of the Schedules 10-K
filed by Newport with the Securities and Exchange Commission,
pursuant to sec. 13 or 15(d) of the Securities Exchange Act of
1934, as amended, described the research agreement, as entered
into with IRC, as being more in the nature of an investment than
a licensing of the technology. The Court further noted that,
even if IRC acquired the technology from Newport, there was no
showing that IRC had the resources to devote to the exploitation
of the technology, nor was there any obligation on the part of
IRC to compel or require capital contributions from its
stockholders. The Court concluded the investments in IRC were
nothing more than an investment in Newport that was structured to
allow the investors in IRC a deduction for their $980,000
investment through purported research and experimental deductions
that would not have been available had the investment been made
directly in Newport.
 -415-

affd. 930 F.2d 372 (4th Cir. 1991); Estate of Cook v.

Commissioner, T.C. Memo. 1993-581.

The Court further holds the Kanters are not entitled to

deductions under section 162 for 1979 with respect to IRC’s

claimed business expense deductions. IRC was not engaged in an

active trade or business during 1979, as IRC’s activities fail to

satisfy even the “in connection” with a trade or business

standard of section 174. See Estate of Cook v. Commissioner,

supra.

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

FINDINGS OF FACT

The notice of deficiency respondent issued to the Kanters

for 1978 included as an attachment a Form 4549-B, Income Tax

Examination Changes, and an accompanying schedule describing the

changes determined in the notice. Item 1h, titled “Partnership

Income” states:
 -416-

It is determined that during the tax year 1978 you
failed to report your distributive share of partnership
income from the sources shown. Consequently, your
taxable income is increased in the amount of $4,953.00.

As Shown Below:

T.C. Family Trust ($512.00)
Everglades Trust No. 1 1,093.00
Everglades Trust No. 2 1,093.00
Everglades Trust No. 3 1,093.00
Everglades Trust No. 4 1,093.00
Everglades Trust No. 5 1,093.00
4,953.00

The notice of deficiency did not identify the partnership(s)

generating the income determined in item 1h. In addition,

although Kanter disputed this adjustment in his petition, he did

not identify the underlying partnership.

On June 13, 1994, respondent filed an amendment to answer

which identified the $4,953 adjustment as “Partnership

Income/Loss (Fuel Boss - Energy Management Systems)”.

No evidence regarding this adjustment was offered by either

party during the trial of these cases.

After trial, on May 15, 1995, the parties submitted to the

Court a stipulation of settlement addressing a number of the

adjustments determined in the notice of deficiency for 1978.

Paragraph 5 of the stipulation of settlement concerns item 1f

from the notice of deficiency and states: “Notice of deficiency

adjustment 1(f), ‘Schedule C--Income/Loss.’ The Court need not
 -417-

address this adjustment at this time, inasmuch as the parties

have agreed that this issue is part of the ‘Energy Management’

project which is under the jurisdiction of Judge Halpern.” The

parties’ stipulation of settlement, however, does not address

item 1h from the notice of deficiency.

OPINION

Respondent’s amendment to answer, filed June 13, 1994,

identified the $4,953 adjustment as “Partnership Income/Loss

(Fuel Boss - Energy Management Systems)”. Under the

circumstances, it appears this issue pertains to the Energy

Management Project and the adjustment was overlooked when the

parties submitted to the Court their stipulation of settlement

for 1978. Consequently, the parties shall make adjustments for

this issue in their computations for entry of decision under Rule

155.

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

On their 1981 income tax return, the Kanters claimed a

$4,283 loss from GLS Associates, a partnership, which respondent

disallowed in the notice of deficiency.

160
The Court’s disposition of this issue represents in
large measure a wholesale adoption of the recommended findings of
fact and conclusions of law set forth in the STJ report.
Petitioners have not registered any specific objections to the
STJ report regarding this issue.
 -418-

OPINION

On brief, petitioners acknowledge there is no specific

evidence in the record establishing the existence of a computer

leasing transaction by GLS Associates Partnership out of which

the claimed loss arose. However, petitioners contend there is

evidence in this record with respect to other computer leasing

transactions entered into by other entities, arguing on brief:

The record is replete with evidence regarding [certain]
computer sale/leaseback transactions [of other
entities]; otherwise neither party submitted any
evidence with respect to * * * [GLS’ computer
sale/leaseback] transaction except that the parties
have both introduced argument and information
pertaining to the case of HGA Cinema Trust v.
Commissioner, T.C. Memo. 1989-370, affd. 950 F.2d 1357
(7th Cir. 1991) * * *.

Petitioners maintain the GLS Associates computer sale/leaseback

transaction was “essentially the same in substance and form” as

the SLG Partners computer sale/leaseback transaction considered

by this Court in HGA Cinema Trust v. Commissioner, T.C. Memo.

1989-370, affd. 950 F.2d 1357 (7th Cir. 1991). Petitioners

appear to refer to evidence presented in connection with an IRA

computer equipment leasing transaction as proof they are entitled

the loss they claimed with regard to GLS Associates.

Respondent, on the other hand, contends petitioners failed

to carry their burden of proof under Rule 142(a).

Petitioners failed to propose any findings of fact on this

issue in their posttrial opening brief. Petitioners are
 -419-

misguided in their attempt to bootstrap this issue with that of

the HGA Cinema Trust case regarding the SLG Partners computer

sale/leaseback transaction. SLG Partners was a separate and

distinct entity from GLS Associates, and the SLG Partners

computer sale/leaseback transaction was a separate and different

transaction from the GLS Associates transaction. It was

incumbent on petitioners to introduce pertinent evidence on the

GLS Associates transaction, as opposed to merely arguing that the

GLS Associates transaction was essentially the same as the SLG

Partners transaction. Petitioners failed to produce any evidence

on this issue, and their self-serving legal arguments on brief do

not constitute evidence. Consequently, the Court sustains

respondent’s determination on this issue. See Rule 142(a).161

161
The Court also finds petitioners’ seeming reliance upon
HGA Cinema Trust v. Commissioner, T.C. Memo. 1989-370, affd. 950
F.2d 1357 (7th Cir. 1991), curious, as petitioners are not
arguing that this Court should reach a conclusion similar to its
conclusion therein. In HGA Cinema Trust, this Court, among other
things, determined that certain long-term promissory notes SLG
Partners issued in connection with the purchase of computer
equipment were not valid indebtedness. The taxpayer in HGA
Cinema Trust was a trust that was a limited partner in SLG
Partners. Kanter was the trust’s trustee and also its counsel in
the litigation before this Court and the U.S. Court of Appeals
for the Seventh Circuit. Moreover, in the instant cases,
although there originally had been certain adjustments at issue
between the parties relating to SLG Partners and K&D Associates
(which latter entity, according to petitioners, simply held an
interest in SLG Partners), those adjustments were settled by the
parties. On May 15, 1995, the parties filed with the Court their
stipulation of settlement as to certain issues between the
Kanters and respondent. Pursuant to the May 15, 1995,
stipulation of settlement, petitioners generally conceded the
underlying SLG Partners and K&D Associates adjustments, except
(continued...)
 -420-

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

On their 1983 and 1984 income tax returns, the Kanters

claimed losses of $83,333 and $161,727, respectively, from an

entity named Equitec. Respondent disallowed the Equitec losses.

OPINION

A. The Parties’ Arguments

Although petitioners offered little, if any, evidence

concerning the computer leasing transactions they contend Equitec

entered into, petitioners argue that “respondent has failed to

recognize the evidence of record regarding the experience of

Kanter vis-a-vis equipment leasing transactions [of other

entities] and the issues of Equitec before this Court.”

Petitioners maintain that Equitec’s transactions should be

reviewed “de novo * * * based upon the testimony and evidence

offered regarding the extensive activity of petitioners in the

161
(...continued)
petitioners did not agree any additions to tax should be imposed
with respect to these conceded adjustments.
162
The STJ report recommended holding that respondent is
barred from making any determination concerning the taxable year
1983 on account of the expiration of the period of limitations
governing assessment and collection for that year. As previously
discussed, we determined that Kanter’s income tax returns for the
years at issue were fraudulent, and, therefore, the period of
limitations remains open pursuant to sec. 6501(c)(1).

The foregoing aside, the Court’s disposition of this issue
represents in large measure a wholesale adoption of the
recommended findings of fact and conclusions of law set forth in
the STJ report with regard to the taxable year 1984.
 -421-

computer leasing field and the pertinence of such experience to

determine the potential [of the] transactions for profit.”

Respondent, on the other hand, contends that petitioners

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

B. Analysis

Petitioners failed to meet their burden of proof on this

issue. Petitioners offered no substantive evidence regarding

Equitec’s computer leasing transactions. Petitioners’ legal

arguments on brief are no substitute for evidence relating to

Equitec’s transactions. For instance, even assuming for the sake

of argument that Kanter’s prior experience in similar investments

may be a relevant factor to be considered in determining whether

Equitec had an actual and honest profit objective, that factor

alone is far from dispositive. See sec. 1.183-2(b), Income Tax

Regs. Consequently, the Court sustains respondent’s

determination on this issue. See Rule 142(a).

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

On their 1981 income tax return, the Kanters deducted

$45,095 identified as investment interest expense related to GLS

Associates. Respondent disallowed this deduction in the notice

of deficiency, which stated in pertinent part:

163
The Court’s disposition of this issue represents in
large measure a wholesale adoption of the recommended findings of
fact and conclusions of law set forth in the STJ report.
 -422-

The above * * * claimed investment interest expense
[from GLS Associates] is disallowed because you have
not substantiated that the entity was engaged in an
activity entered into for profit or that the investment
interest expense was paid or incurred by the entity
during the taxable year, or if paid or incurred, was
deductible.

OPINION

A. The Parties’ Arguments

Petitioners essentially advance the same arguments they

raised above relating to (1) the partnership loss they claimed

with respect to GLS Associates for 1981; and (2) the loss they

claimed from Equitable Leasing for 1984, which the Court has

rejected. Petitioners contend the GLS Associates leasing

transaction in issue is substantially the same as the SLG

Partners’ leasing transactions and the Court should consider

Kanter’s experience with other entities in the equipment leasing

field.

Respondent contends petitioners failed to carry their burden

of proof on this issue under Rule 142(a).

B. Analysis

Petitioners failed to offer sufficient substantive evidence

concerning GLS Associates’ purported leasing transaction and GLS

Associates’ claimed investment interest expense for 1981 to

sustain their burden of proof. Self-serving legal arguments on

brief are not evidence and do not suffice to sustain the burden

of proof. For instance, even assuming for the sake of argument
 -423-

that Kanter’s prior experience with similar investments is a

relevant factor in determining whether GLS Associates had an

actual and honest profit objective, that factor alone is far from

dispositive. See sec. 1.183-2(b), Income Tax Regs. Petitioners

failed to establish that: (1) GLS Associates was engaged in an

activity for profit; (2) GLS Associates incurred and paid the

claimed investment interest expense; and (3) even assuming the

investment interest expense was incurred, that such interest

expense is deductible. Consequently, the Court sustains

respondent’s determination on this issue. See Rule 142(a).

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

On their 1978 income tax return, the Kanters claimed a

$120,566 investment tax credit carryover. Respondent disallowed

the tax credit in the notice of deficiency.

OPINION

A. The Parties’ Arguments

Petitioners contend that their entitlement to the 1978

investment tax credit carryover is purely “computational” under

Rule 155. Petitioners 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

164
The Court’s disposition of this issue represents in
large measure a wholesale adoption of the recommended findings of
fact and conclusions of law set forth in the STJ report.
 -424-

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 his proposed finding] 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. (Tr. 4825). 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 among the Court, petitioners’ counsel, and respondent’s

counsel concerning the parties’ settlement of a number of other

adjustments for the years at issue.

Respondent contends petitioners failed to carry their burden

of proof under Rule 142(a).

B. Analysis

During the trial of these cases, Kanter’s counsel suggested

that he would read into the record the issues the parties had

settled. Transcr. at 4823. The Court rejected this proposal and

instead directed the parties to submit to the Court a

comprehensive written stipulation of settlement. Transcr. at

4823-4825. The Court’s objective was to avoid the confusion that

an oral presentation of the settled issues was likely to create.

Id.
 -425-

Petitioners’ entitlement to an investment tax credit

carryover for 1978 is not addressed in the stipulation of

settlement the parties filed with the Court on May 15, 1995.

Petitioners now nevertheless contend that the disposition of the

credit carryover issue is tied to the resolution of the

underlying investment tax credit issue for 1977--a year that was

not before the Court in these consolidated cases

The Court rejects petitioners’ argument as contrary to the

burden placed upon them under Rule 142(a). Petitioners presented

no evidence to establish the existence of, nor their entitlement

to, the claimed carryover. See Leavell v. Commissioner, T.C.

Memo. 1996-117.165 Moreover, petitioners must bear responsibility

for submitting to the Court a stipulation of settlement that does

not make any reference to this issue. Since there are several

factual matters that must be established to prove the amount of

the carryover that were not established at trial, the Rule 155

computational process is not a forum within which this matter can

be considered. See Price v. Commissioner, T.C. Memo. 1995-290.

The Court, therefore, rejects petitioners’ argument that this

issue is computational under Rule 155. Respondent is sustained

on this issue.

165
For example, the burden of proof includes not only
establishing the amount of the investment credit for the year the
credit was earned but also establishing what portion of the
credit was absorbed or applied in the carryback of the credit to
prior years, after which the remaining amount of the credit can
be applied to the first carryforward year.
 -426-

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

On Schedule E of their 1986 income tax return, the Kanters

claimed a $50,380 deduction for “interest computers”. Respondent

disallowed this deduction in the notice of deficiency.

OPINION

A. The Parties’ Arguments

Petitioners contend either (1) they should be allowed their

claimed interest deduction, or (2) the net income they reported

for 1986 from the related computer leasing activity should be

disregarded or eliminated. Petitioners argue on brief, in

pertinent part:

[In his proposed finding of fact], respondent
asserts that the * * * computer equipment leasing
deduction disallowed for 1986 is from the same Equitec
investment which was disallowed in the subsequently
issued notice of deficiency issued relative to * * *
[the Kanters’] 1984 year * * *. Both [the notice of
deficiency for 1984 and the notice of deficiency for
1986] * * * contain boilerplate language disallowing
Kanter’s computer leasing related interest deduction,
on a variety of grounds typically used to attack
perceived equipment leasing tax shelters. Most
significantly, * * * [respondent’s] notice of
deficiency claimed that Kanter failed to establish that
“the activity was entered into for profit or was
economically viable.” However, respondent’s notice of
deficiency for 1986, in contrast to the notice issued
to Kanter concerning this same investment for 1984,
fails to take into account (i.e., reverse) the rental
income reported from this computer equipment
transaction.

166
The Court’s disposition of this issue represents in
large measure a wholesale adoption of the recommended findings of
fact and conclusions of law set forth in the STJ report.
 -427-

It is submitted that Kanter’s $50,380 1986
Schedule E interest deduction must be viewed in
conjunction with the Schedule E rents reported and
depreciation claimed from the equipment leasing
activity. Kanter introduced his Schedule E with
respect to the computer leasing activity involved * * *
revealing that he reported rents in 1986 from the
leasing activity involved of $118,835, and claimed
depreciation of $61,730, for a net taxable gain of
$6,725.

Respondent contends petitioners failed to meet their burden

of proof under Rule 142(a).

B. Analysis

The Equitec computer leasing transaction referred to above

relative to the Kanters’ 1984 tax year was resolved in

respondent’s favor. With regard to the 1984 loss issue, we held

that the Kanters failed to sustain their burden of proof because

they failed to offer substantive evidence on the merits of the

activity. For the 1986 tax year, which involves the same Equitec

activity, petitioners claim that either the interest claimed for

1986 should be allowed as a deduction, or the net income reported

from the activity for 1986 should be disregarded or eliminated.

Here again, the record does not include any substantive

evidence regarding the merits of the Equitec computer leasing

activity. There likewise is no evidence regarding the merits of

the indebtedness upon which the interest payments were

purportedly made by the Kanters. As noted in petitioners’ brief,

respondent disallowed the various expenses claimed in connection

with Equitec “on a variety of grounds typically used to attack
 -428-

perceived equipment leasing tax shelters.” The fact that the

leasing activity generated a profit (for 1986) does not impress

the Court as proof that petitioners are entitled to an interest

expense deduction for 1986. By the same token, the disallowance

of expenses claimed with respect to an activity does not mean

that the income or gross receipts of the activity can be

disregarded. Section 1.183-1(e), Income Tax Regs., provides, in

pertinent part, that “gross income derived from an activity not

engaged in for profit includes the total of all gains from the

sale, exchange, or other disposition of property, and all other

gross receipts derived from such activity.” Such gross income

shall include, for instance, capital gains and rents received for

the use of property that is held in connection with the activity.

The gross receipts of an activity, even if the activity is not

engaged in for profit, constitute gross income, and there is no

provision for the exclusion or the disregarding of such income

simply because the expenses related thereto are not deductible.

Petitioners, therefore, failed to sustain their burden of

proving their entitlement to an interest deduction of $50,380 for

1986, and the Court rejects petitioners’ contention the net

income of the activity for 1986 should be disregarded.

Respondent’s determination on this issue is sustained.
 -429-

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

Respondent disallowed a deduction of $104,231 that

petitioners claimed on Schedule C of their 1980 tax return. The

deduction related to a joint venture between two of Kanter’s

clients, Feigan and Rappaport, to purchase a painting of George

Washington. Kanter was instrumental in bringing the two

businessmen together at the start of the venture. The

transaction subsequently soured, the painting was returned to its

original owner, and, although the seller returned the full

purchase price, Rappaport, who provided the funds for the

purchase, lost money on account of an intervening decline in the

value of the British pound against the U.S. dollar. A dispute

between Rappaport and Feigan ensued, Kanter convinced Feigan to

make Rappaport whole, and Kanter contributed $104,231 to

reimburse Rappaport.

OPINION

A. The STJ Report

The STJ report recommended findings of fact and conclusions

of law that Kanter was not engaged in a trade or business of

dealing in art, and, therefore, respondent’s determination

disallowing the deduction should be sustained.

B. The Parties’ Arguments

Kanter argued the deduction should be permitted because he

made the $104,231 payment to protect his professional reputation
 -430-

and he felt an obligation to shoulder a share of the loss because

he had acted as a “broker”. Petitioners’ Reply Brief at 1407.

Although respondent argued on brief that his determination

disallowing the deduction should be sustained, respondent

conceded in his objection to the STJ report that this

transaction, like several of the transactions Kanter engaged in

with The Five, served to demonstrate that Kanter routinely used

his business and professional contacts to assist clients in

obtaining business or in raising capital for business ventures.

Citing the Court of Appeals for the Seventh Circuit’s treatment

of this issue in Estate of Kanter v. Commissioner, 337 F.3d at

855-856, respondent concedes Kanter is entitled to the disputed

deduction. We accept respondent’s concession of this issue.

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

FINDINGS OF FACT

Sometime during 1982, Jewish United Fund (JUF) solicited

Kanter for a donation. On or about December 17, 1982, THC

executed a $15,000 promissory note, payable to Kanter, due on

March 1, 1983, and bearing interest at 12 percent per annum. On

December 27, 1982, THC enclosed in a letter to JUF (1) the

$15,000 promissory note payable to Kanter, and (2) Kanter’s

completed pledge card for a $15,000 donation to JUF. The
 -431-

December 27, 1982, letter stated: “THC 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 THC promissory note. The

December 30, 1982, letter further stated that “This note has been

assigned by you to * * * JUF as a charitable contribution, and we

are pleased to accept it as such.”

On February 28, 1983, THC paid to Kanter the full $15,000 in

principal due on the promissory note, plus interest of $370. On

that same date, Kanter then paid $15,000 to JUF by issuing to JUF

his own $15,000 check. Kanter did not pay over to JUF the $370

in interest he received on the THC promissory note.

On their 1982 income tax return, the Kanters claimed a

$15,000 charitable deduction for Kanter’s contribution to JUF.

On their 1983 income tax return, the Kanters reported the $370 in

interest THC paid on the THC note as interest income. Respondent

disallowed the $15,000 JUF charitable contribution deduction

claimed by the Kanters.

OPINION

A. The Parties’ Arguments

Petitioners contend they are entitled to a charitable

contribution deduction for 1982 of at least $14,700, which they

maintain was the THC promissory note’s fair market value on the

date of its contribution to JUF in December 1982. Petitioners
 -432-

assert: “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.” Petitioners 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

set in the note itself), the 1982 deduction should be discounted

not more than $300.

Respondent contends the Kanters are not entitled to a

charitable contribution deduction for 1982 because: (1) There

was no endorsement of the THC promissory note by Kanter to JUF,

and (2) the Kanters failed to establish the note’s fair market

value as of the date of its purported contribution to JUF in late

1982.

B. The STJ Report

The STJ report recommended holding that the Kanters are

entitled to a charitable contribution deduction of $14,630 for

1982 related to the JUF transaction. We reject the

recommendation in the STJ report because it is erroneous as a

matter of law.

C. Analysis

Section 170(a) generally provides that a deduction is

allowed for a charitable contribution, payment of which is made

within the taxable year. Payment to a charity generally occurs
 -433-

when the donee relinquishes control over the property to the

donee. See, e.g., Goldstein v. Commissioner, 89 T.C. 535, 542

(1988).

The record shows that Kanter did not make a payment to JUF

during 1982. In short, THC forwarded to JUF a $15,000 promissory

note payable to Kanter along with a letter which stated: “THC

will pay its note to Kanter, who will, in turn, see to providing

these funds to JUF.” In accordance with this letter, THC paid

$15,370 to Kanter in February 1983, and Kanter forwarded $15,000

to JUF at that time.

On these facts, it is evident Kanter did not endorse the

promissory note over to JUF during 1982 or otherwise relinquish

control of the promissory note to JUF at any time. In the

absence of a payment to JUF during 1982 within the meaning of

section 170(a), it follows that the Kanters are not entitled to a

charitable contribution deduction for 1982. Nevertheless, Kanter

did make a $15,000 charitable contribution to JUF during 1983,

and, thus, the Kanters are entitled to a deduction for that year,

subject to the adjusted gross income limitations of section

170(b).
 -434-

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

OPINION

Respondent determined in the notice of deficiency for 1982

that Kanter is liable for additional self-employment tax of $848.

Inasmuch as respondent’s determination turns on the disposition

of other adjustments respondent determined for 1982, the amount

of Kanter’s self-employment tax will be determined in the

parties’ computations for entry of decision pursuant to Rule 155.

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

Respondent determined in the notice of deficiency issued to

the Kanters for 1987 that they were not entitled to capital

losses arising from various sales of stocks, bonds, promissory

notes, and partnership interests to Mallin, MAF, Inc., Windy

City, Inc., and others. These adjustments were resolved against

petitioners and the decision entered by the Court at docket No.

24002-91 for the taxable year 1987 on September 24, 2001, was not

167
The STJ report recommended alternative holdings that
turned on whether the self-employment tax issue was inadvertently
omitted from the parties’ stipulated settlement. If so, the STJ
report proposed to hold for petitioners. On the other hand, if
the matter was purely computational, the matter would be
addressed in the parties’ Rule 155 computations. The Court
concludes, on the basis of the manner in which the issue is set
forth in the notice of deficiency, that this issue is purely
computational.
 -435-

appealed and is otherwise final. See secs. 7481(a)(1), 7483.

Consequently, we need not consider this issue.

Issue XXIV. Additions to Tax and Related Matters

OPINION

In some of the notices of deficiency issued to the Kanters

and/or in amended pleadings filed in the Kanters’ cases,

respondent determined (as an alternative to respondent’s

determination the Kanters were liable for additions to tax for

fraud) that the Kanters were liable for additions to tax under

section 6653 (negligence), section 6659 (substantial valuation

overstatement), section 6661 (substantial understatement of tax),

and increased interest under section 6621(c).

The STJ report, at 265-293, recommended holding (1) the

Kanters were liable for additions to tax under sections 6653,

6659, and 6661 for the years in question, and (2) the Kanters

were liable for increased interest for 1980, 1984, 1986, and

1987.

Inasmuch as respondent asserted these additions to tax

against Kanter strictly as alternatives to respondent’s assertion

of the fraud additions (which we sustained above with regard to

income Kanter earned from The Five), we need not consider the

alternative additions to tax.
 -436-

To reflect the foregoing,

Appropriate orders will be issued

(1) striking from respondent’s amendment

to answer filed at docket No. 31301-87

increased deficiencies for 1978, and (2)

granting respondent’s oral motion to

conform the pleadings to the proof at

docket No. 26251-90, and decisions will

be entered pursuant to Rule 155.
 -437-

APPENDIX 1

Frey’s payments to IRA’s subsidiary Zeus during 1980-85:

Date Payments Exhibits

1980 $127,372 12, Stmts. 7, 25, at 7,
“Zeus” column; Kuck, Transcr.
at 3371-3373.
1981 105,764 14, at 7, “Zeus” column,
ll. 2, 6, and 7; 5814
and 5817; Kuck, Transcr. at
3378-3384
1982 538,781 17, at 16, Zeus column,
l. 4; Kuck, Transcr. at 3409
1-17-83 6,875 224
2-16-83 9,375 224
3-14-83 11,875 456
4-19-83 7,500 456
5-24-83 7,500 456
6-30-83 7,500 5815, 5818
7-25-83 7,500 456
8-5-83 7,500 456
9-7-83 7,500 456
10-7-83 7,500 456
11-21-83 7,250 456
12-16-83 7,250 224, at 11
11-3-83 15,000 456
110,125 18, at 20 “Zeus” column

1-13-84 $7,250 456
2-14-84 7,250 456
3-15-84 7,250 456
4-15-84 7,250 456
6-7-84 7,250 456
7,250 456
7-24-84 7,250 225
7,250 225
10-5-84 23,392 225
4,108 225
12-4-84 18,000 457; 5819
103,500 19, at 12, “Zeus” column
1-31-85 1,625 457 (Bates 000022, 000023)
3-29-85 3,250 457 (Bates 000025, 000024)
4-10-85 123,888 457 (Bates 000026)
128,763 20, 16, “Zeus” column
Total 1,114,305
 -438-

APPENDIX 2

Carlco’s officers and directors during 1982 through 1989:

Title 1982 1983 1984

Directors Kanter Freeman --
Carl Kanter Meyers --
President Carl Kanter Meyers Henry Lisle
Vice president Kanter -- Donna Lisle
Secretary Meyers Gallenberger D. Dubanevich
Treasurer Meyers Meyers --
Assistants Meyers -- --

Title 1985 1986 1987

Directors -- -- --
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 -- --
President Henry Lisle Robert Lisle
Vice president Donna Lisle Thomas Lisle
Secretary Dubanevich Donna Lisle
Treasurer Gallenberger Gallenberger
Assistants -- --
Exhs. 67, 2086, 424, 477.
 -439-

APPENDIX 3

TMT’s officers and directors during 1982 through 1989:

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 -- --

Exh. 91.
 -440-

APPENDIX 4

BWK’s officers and directors during 1982 through 1990:

Title 1982 1983 1984

Directors Kanter Weisgal Weisgal
Joshua Kanter -- --
Meyers -- --
President Kanter Weisgal Weisgal
Vice president Meyers -- --
Secretary Meyers Meyers Meyers
Treasurer Meyers Meyers Meyers
Assistants -- -- --

Title 1985 1986 1987

Directors Weisgal Weisgal Weisgal
President Weisgal Weisgal Weisgal
Secretary Gallenberger Gallenberger Gallenberger
Kanter Kanter --
Secretary Gallenberger Gallenberger Gallenberger
Treasurer -- -- --
Assist. sec. Snedden Snedden Snedden

Title 1988 1989 1990

Directors Weisgal Weisgal Kanter
President Weisgal Weisgal Kanter
Vice president Gallenberger Gallenberger --
Kanter Kanter --
Secretary Gallenberger Gallenberger Gallenberger
Treasurer -- Kanter --
Assist. sec. Snedden Snedden Snedden

Exhs. 112, 2009.
 -441-

APPENDIX 5

During 1984 to 1989, IRA made loans to KWJ Partnership as

follows:

Date Amount Exhibit

3-22-84 $3,000 29, at 15
4-24-84 3,000
5-29-84 3,000
6-29-84 3,000
7-30-84 3,000
9-12-84 3,000
9-26-84 3,000
11-7-84 4,000
11-29-84 4,000
12-26-84 4,000
12-31-84 adj.(3,000)
30,000

1-21-85 4,000 32, at 13
2-21-85 4,000
3-5-85 1,500
3-22-85 4,000
4-25-85 4,000
5-28-85 4,000
6-24-85 4,000
7-8-85 4,000
8-27-85 4,000
9-23-85 4,000
10-18-85 4,000
12-2-85 4,000
45,500

1-3-86 4,000 33, at 8-9
1-31-86 4,000
3-3-86 4,000
7-8-86 2,000
7-29-86 4,000
8-15-86 20,000
38,000

1-8-87 20,000 9000, at 9
7-16-87 8,000
10-20-87 12,000 34, at 3
11-30-87 8,000
48,000
 -442-

APPENDIX 5
(Continued)

3-31-88 20,000 35, at 3
11-27-89 68,370 36, at 5
Total 249,870 9077, Kuck Summary #3
 -443-

APPENDIX 6

During 1985 to 1989, IRA transferred the payments that it

received from PMS to Carlco, TMT, and BWK in a 45/45/10 percent

split as follows:

Payments IRA Cash Distributions
Date From PMS Carlco TMT BWK Total Exhibit

1-9-85 90,423 -- -- -- -- 320
4-3-85 90,423 -- -- -- -- 323
7-1-85 90,423 -- -- -- -- 325
10-2-85 90,423 -- -- -- -- 327
Total 361,692 $162,000 $162,000 $36,000 $360,000 32, at 15-16

1-7-86 90,423 -- -- -- -- 329
5-15-86 90,423 -- -- -- -- 330
7-2-86 90,423 -- -- -- -- 332
9-30-86 90,423 -- -- -- -- 334
Total 361,692 $162,370 $162,370 $36,082 $360,822 33, at 12

1-12-87 90,423 -- -- -- -- 335
5-1-87 90,423 -- -- -- -- 336
7-2-87 90,423 -- -- -- -- 337
10-14-87 90,423 -- -- -- -- 338
Total 361,692 $192,313 $192,313 $36,169 $420,795 9000, at 11
34, at 7-8
1-22-88 90,423 -- -- -- -- 339
4-27-88 90,423 -- -- -- -- 340
7-18-88 90,423 -- -- -- -- 341
10-24-88 90,423 -- -- -- -- 342
361,692 $162,760 $162,760 $36,169 $316,691 35, at 7

1-9-89 90,423 – -- -- -- 343
1
750,000 – -- -- --
840,423 $378,190 $378,190 $84,042 $840,422 36, at 8
Total 2,287,191 2,298,730

1
This $750,000 payment was remitted by PMS to PSAC per Kanter’s
instructions. Nevertheless, PSAC transferred this money to IRA for
distribution to Carlco, TMT, and BWK in a 45/45/10 split.
 -444-

APPENDIX 7

During 1983, THC transferred $2,335,298 to TACI’s accounts

as follows:

Date Amount Exhibit

1-6-83 $36,000 148, at 3
1-24-83 100,000 148, at 3
1-25-83 79,164 148, at 3
2-16-83 50,000 148, at 4
2-18-83 70,000 148, at 4
3-2-83 20,000 148, at 4
3-21-83 50,000 148, at 4
3-28-83 100,000 148, at 4
3-31-83 15,000 148, at 4
4-7-83 60,000 148, at 4
4-11-83 40,000 148, at 5
5-11-83 110,000 148, at 5
5-17-83 180,000 148, at 5
5-23-83 35,000 148, at 6
5-31-83 130,000 148, at 6
6-9-83 15,000 148, at 6
6-15-83 44,000 148, at 6
6-21-83 30,000 148, at 6
7-7-83 8,600 148, at 7
7-11-83 100,000 148, at 7
7-17-83 50,000 148, at 7
8-5-83 80,000 148, at 7
8-18-83 30,000 148, at 8
12-23-83 1,000 148, at 8
12-28-83 21,000 148, at 8
12-29-83 60,000 148, at 8
9-1-83 80,000 149, at 1
9-2-83 6,100 149, at 1
9-6-83 30,000 149, at 1
9-14-83 160,000 149, at 1
9-15-83 33,334 149, at 1
9-20-83 200,000 149, at 1
9-20-83 11,100 149, at 1
10-14-83 20,000 149, at 2
10-19-83 30,000 149, at 2
12-19-83 250,000 174, at 112
Total 2,335,298
 -445-

APPENDIX 8

TACI transferred $1,339,843 to THC during 1983 as follows:

Check
Bates Stamped Dated No. Payable Amount

0-0002732 1-4-83 1186 THC 95,000
0-0002756 1-11-83 1198 THC 35,000
0-0002762 1-12-83 1201 THC 8,000
0-0002810 2-4-83 1227 THC 60,000
0-0002868 2-25-83 1258 THC 20,000
0-0002894 3-4-83 1271 THC 15,000
0-0002946 3-24-83 1297 THC 18,000
0-0002958 3-30-83 1303 THC 125,000
0-0002982 4-4-83 1315 THC 68,000
0-0003112 4-19-83 1405 THC 25,000
0-0003162 5-9-83 1432 THC 106,000
0-0003166 5-10-83 1434 THC 50,000
0-0003184 5-17-83 1444 THC 15,000
0-0003192 5-26-83 1448 THC 59,843
0-0003214 6-2-83 1461 THC 25,000
0-0003218 6-3-83 1463 THC 30,000
0-0003270 6-29-83 1491 THC 28,000
0-0003356 8-11-83 1538 THC 10,000
0-0003374 8-15-83 1547 THC 5,000
0-0003378 8-15-83 1549 THC 41,000
0-0003380 8-16-83 1551 THC 16,000
0-0003466 9-21-83 1602 THC 50,000
0-0003468 9-23-83 1603 THC 76,000
0-0003496 10-3-83 1618 THC 43,000
0-0003512 10-6-83 1627 THC 15,000
0-0003514 10-6-83 1628 THC 20,000
0-0003532 10-18-83 1639 THC 10,000
0-0003582 10-25-83 1664 THC 30,000
0-0003586 10-25-83 1666 THC 8,000
0-0003588 10-25-83 1667 THC 8,000
0-0003590 10-25-83 1668 THC 53,000
0-0003594 10-26-83 1670 THC 15,000
0-0003622 11-4-83 1685 THC 1,500
0-0003658 11-23-83 1705 THC 15,000
0-0003662 11-28-83 1707 THC 60,000
0-0003686 12-7-83 1720 THC 10,000
0-0003752 12-28-83 1756 THC 50,000
0-0003762 12-30-83 1761 THC 20,500
Total 1,339,843

Exh. 5406.
 -446-

APPENDIX 9

THC transferred $1,194,000 to TACI during 1984 as follows:

Date Amount Exhibit

2-10-84 $25,000 149, at 3
2-16-84 1,000 149, at 3
2-16-84 1,000 149, at 3
3-15-84 20,000 149, at 4
4-13-84 60,000 149, at 4
4-18-84 10,000 149, at 4
4-25-84 50,000 149, at 4
5-23-84 13,000 149, at 5
7-20-84 50,000 149, at 5
8-10-84 30,000 149, at 6
8-24-84 37,000 149, at 6
9-10-84 125,000 150, at 1
9-21-84 20,000 150, at 1
10-2-84 110,000 150, at 1
10-10-84 30,000 150, at 1
11-14-84 345,000 150, at 1
11-15-84 140,000 150, at 1
11-21-84 37,000 150, at 1
12-31-84 90,000 150, at 2
Total 1,194,000
 -447-

APPENDIX 10

TACI transferred $756,300 to THC during 1984 as follows:
Check
Bates Stamped Dated No. Payable Amount

0-0003766 1-4-84 1763 THC $2,650
0-0003768 1-4-84 1764 THC 2,650
0-0003804 1-13-84 1785 THC 25,000
0-0003826 1-24-84 1797 THC 1,000
0-0003828 1-24-84 1798 THC 1,000
0-0003854 1-31-84 1811 THC 1,000
0-0003890 2-13-84 1829 THC 500
0-0003892 2-13-84 1830 THC 500
0-0003894 2-13-84 1831 THC 5,000
0-0003898 2-14-84 1833 THC 39,000
0-0003938 2-17-84 1853 THC 9,000
0-0003974 3-7-84 1872 THC 106,000
0-0004002 3-22-84 1887 THC 90,000
0-0004016 3-26-84 1894 THC 12,000
0-0004076 4-19-84 1927 THC 5,000
0-0004106 5-1-84 1942 THC 55,000
0-0004160 5-3-84 1970 THC 27,000
0-0004298 6-21-84 2039 THC 117,000
0-0004318 6-28-84 2049 THC 40,000
0-0004324 6-29-84 2052 THC 15,000
0-0004330 7-2-84 2057 THC 5,000
0-0004348 7-3-84 2067 THC 20,000
0-0004378 7-11-84 2084 THC 25,000
0-0004414 7-25-84 2106 THC 50,000
0-0004500 8-23-84 2153 THC 29,000
0-0004670 10-24-84 2247 THC 4,000
0-0004692 10-30-84 2260 THC 2,000
0-0004698 11-1-84 2263 THC 5,000
0-0004754 12-4-84 2294 THC 5,000
0-0004784 12-13-84 2311 THC 7,000
0-0004794 12-18-84 2316 THC 15,000
0-0004800 12-20-84 2321 THC 20,000
0-0004804 12-21-84 2323 THC 7,000
0-0004786 12-14-84 2312 THC 8,000
Total 756,300

Exh. 5406.
 -448-

APPENDIX 11

During 1983, $407,458 was transferred from the TACI account

to Kanter’s personal bank account purportedly as loans, as

follows:

Bates Stamped Check
Deposited Dated No. Payable Amount Memo

0-0002988 4-5-83 1318 Burton Kanter $15,000 --
0-0003160 5-9-83 1431 Burton Kanter 55,000 --
0-0003282 7-5-83 1497 Burton Kanter 50,000 --
0-0003284 7-6-83 1498 Burton Kanter 2,000 --
0-0003288 7-7-83 1500 Burton Kanter 1,000 Loan
0-0003296 7-12-83 1504 Burton Kanter 35,000 Loan
0-0003314 7-19-83 1514 Burton Kanter 15,000 --
0-0003332 7-25-83 1525 Burton Kanter 25,000 Loan
0-0003396 8-25-83 1560 Burton Kanter 5,000 --
0-0003402 8-26-83 1563 Burton Kanter 5,000 --
0-0003404 8-30-83 1565 Burton Kanter 55,000 Loan
0-0003410 8-31-83 1568 Burton Kanter 25,000 Loan
0-0003452 9-16-83 1595 Burton Kanter 22,000 Loan
0-0003464 9-20-83 1601 Burton Kanter 5,000 Loan
0-0003478 9-27-83 1608 Burton Kanter 5,000 Loan
0-0003526 10-17-83 1635 Burton Kanter 5,000 Loan
0-0003530 10-18-83 1638 Burton Kanter 2,500 Loan
0-0003534 10-18-83 1640 Burton Kanter 5,000 Loan
0-0003538 10-19-83 1642 Burton Kanter 1,500 --
0-0003548 10-21-83 1647 Burton Kanter 1,000 Loan
0-0003554 10-21-83 1650 Burton Kanter 2,000 Loan
0-0003578 10-24-83 1662 Burton Kanter 1,500 Loan
0-0003596 10-28-83 1671 Burton Kanter 42,958 Loan
0-0003678 12-6-83 1716 Burton Kanter 6,000 Loan
0-0003708 12-15-83 1732 Burton Kanter 10,000 Loan
0-0003756 12-29-83 1758 Burton Kanter 10,000 Loan
Total 407,458

Exh. 5407.
 -449-

APPENDIX 12

During 1984, $909,000 was transferred from the TACI Special

account to Kanter’s personal bank account purportedly as loans,

as follows:
Check
Bates No. Dated No. Payable Amount Memo

0-0003812 1-19-84 1789 Burton Kanter $25,000 Loan
0-0003824 1-24-84 1796 Burton Kanter 5,000 --
0-0003844 1-27-84 1806 Burton Kanter 2,000 Loan
0-0003852 1-31-84 1810 Burton Kanter 2,000 Loan
0-0003880 2-7-84 1824 Burton Kanter 25,000 Loan
0-0003902 2-14-84 1835 Burton Kanter 5,000 Loan
0-0003922 2-16-84 1845 Burton Kanter 5,000 Loan
0-0003942 2-23-84 1855 Burton Kanter 20,000 Loan
0-0003952 3-1-84 1861 Burton Kanter 15,000 Loan
0-0003956 3-2-84 1863 Burton Kanter 6,000 Loan
0-0004004 3-22-84 1888 Burton Kanter 10,000 Loan
0-0004028 3-29-84 1900 Burton Kanter 26,000 Loan
0-0004082 4-23-84 1930 Burton Kanter 2,500 Loan
0-0004092 4-27-84 1935 Burton Kanter 30,000 Loan
0-0004174 5-15-84 1977 Burton Kanter 30,000 Loan
0-0004194 5-17-84 1987 Burton Kanter 5,000 Loan
0-0004198 5-21-84 1989 Burton Kanter 70,000 Loan
0-0004208 5-23-84 1994 Burton Kanter 5,000 Loan
0-0004210 5-24-84 1995 Burton Kanter 5,000 Loan
0-0004222 5-30-84 2001 Burton Kanter 10,000 Loan
0-0004230 5-31-84 2005 Burton Kanter 4,000 Loan
0-0004234 6-1-84 2007 Burton Kanter 1,000 --
0-0004272 6-13-84 2026 Burton Kanter 1,500 Loan
0-0004274 6-14-84 2027 Burton Kanter 55,000 Loan
0-0004784 6-20-84 2032 Burton Kanter 20,000 Loan
0-0004296 6-21-84 2038 Burton Kanter 5,000 --
0-0004312 6-26-84 2046 Burton Kanter 10,000 Loan
0-0004342 7-3-84 2064 Burton Kanter 15,000 Loan
0-0004366 7-9-84 2077 Burton Kanter 15,000 --
0-0004376 7-11-84 2082 Burton Kanter 5,000 Loan
0-0004382 7-17-84 2086 Burton Kanter 17,000 Loan
0-0004406 7-24-84 2101 Burton Kanter 15,000 Loan
0-0004432 8-1-84 2118 Burton Kanter 10,000 Loan
0-0004460 8-8-84 2132 Burton Kanter 10,000 Loan
0-0004482 8-17-84 2143 Burton Kanter 20,000 Loan
0-0004488 8-21-84 2146 Burton Kanter 56,000 Loan
0-0004492 8-22-84 2149 Burton Kanter 70,000 Loan
0-0004564 9-14-84 2187 Burton Kanter 6,000 Loan
 -450-

APPENDIX 12
(Continued)

0-0004572 9-17-84 2191 Burton Kanter 55,000 Loan
0-0004576 9-18-84 2196 Burton Kanter 7,000 Loan
0-0004586 9-24-84 2202 Burton Kanter 5,000 Loan
0-0004608 10-3-84 2216 Burton Kanter 175,000 Loan
0-0004618 10-5-84 2221 Burton Kanter 8,000 Loan
0-0004728 11-20-84 2280 Burton Kanter 15,000 Loan
0-0004732 11-21-84 2283 Burton Kanter 5,000 Loan
Total 909,000

Exh. 5407.
 -451-

APPENDIX 13

During 1983, $24,000 was transferred from the TACI account

to Kanter’s personal bank account purportedly as retainer fees,

as follows:

Date Amount Exhibit

1-3-83 $2,000 148, at 3
2-2-83 2,000 148, at 3
3-14-83 2,000 148, at 4
3-31-83 2,000 148, at 4
5-2-83 2,000 148, at 5
6-1-83 2,000 148, at 6
6-27-83 2,000 148, at 7
8-1-83 2,000 148, at 7
9-2-83 2,000 149, at 1
9-20-83 2,000 149, at 1
11-1-83 2,000 149, at 2
12-1-83 2,000 149, at 2
Total 24,000
 -452-

APPENDIX 14

During 1984, $24,000 was transferred from the TACI account

to Kanter’s personal bank account purportedly as retainer fees,

as follows:

Date Amount Exhibit

1-3-84 $2,000 149, at 3
2-2-84 2,000 149, at 3
3-1-84 2,000 149, at 4
4-3-84 2,000 149, at 4
5-1-84 2,000 149, at 4
7-3-84 2,000 149, at 5
8-1-84 2,000 149, at 6
8-30-84 2,000 149, at 6
10-1-84 2,000 150, at 1
11-1-84 2,000 150, at 1
12-4-84 2,000 150, at 1
12-6-84 2,000 150, at 1
Total 24,000
 -453-

APPENDIX 15

During 1984, $161,000 was transferred from the TACI account

to Kanter’s personal bank account purportedly as loans, as

follows:
Check Check
Date No. Payable to Amount Memo

3-16-84 1878 Burton Kanter $106,000 Loan
3-23-84 1890 Burton Kanter 25,000 Loan
8-9-84 1975 Burton Kanter 5,000 Loan
8-13-84 2136 Burton Kanter 5,000 Loan
9-27-84 2207 Burton Kanter 10,000 Loan
11-27-84 2287 Burton Kanter 10,000 Loan
Total 161,000

Exh. 9078; Kuck, Transcr. at 3482-3490.
 -454-

APPENDIX 16

The IRS issued the following summonses:

Tax
Summons Issued to Year Date of Summons Exhibit

Claude Ballard 1984 July 25, 1991 484
Linda Gallenberger 1984 Jan. 10, 1991 485
(In the matter of
Claude & Mary
Ballard)
Linda Gallenberger 1984 Jan. 10, 1991 486
(In the matter of
Robert Lisle &
Donna Lisle)
Linda Gallenberger 1984 Jan. 10, 1991 487
(In the matter of
Claude & Mary
Ballard)
Donna Lisle 1984 July 30, 1991 488
Linda Gallenberger 1984 Jan. 10, 1991 489
Robert Lisle 1988 July 30, 1991 490
Linda Gallenberger 1984 Jan. 10, 1991 491
Officer, PSAC
(In the matter of
Robert Lisle &
Donna Lisle)
PSAC 1983, Oct. 1, 1990 9046
(In the matter of 1985-88
Burton & Naomi
Kanter)
Mildred Schott 1983, Apr. 30, 1990 492
(In the matter of 1985-88
Burton & Naomi
Kanter)

Lunk, Transcr. at 1045-1052.
 -455-

APPENDIX 17

Original and additional beneficiaries of the Bea Ritch

Trusts:

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

Joshua Trust Burton & Joshua JSK 2d Trust #18
Kanter JSK 3d Trust #18

Joel Childrens Burton & Naomi JSK 3d Trust #17
Trust Joel & Joel’s JSK 1st Trust #18
children living
Janis Childrens Burton & Naomi JSK 2d Trust #16
Trust Janis & Janis’s JSK 3d Trust #16
children living
from time to time

Joshua Childrens 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
 -456-

APPENDIX 17
(Continued)

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’s 1st child JSK 3d Trust #9

JA-2 Trust Burton & Janis JSK 1st Trust #10
Helen Krakow & JSK 2d Trust #10
Janis’s 3d child JSK 3d Trust #10

JA-3 Trust Burton & Janis JSK 1st Trust #11
Evelyn Krakow & JSK 2d Trust #11
Janis’s 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

BK Childrens Burton, Naomi, & 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
 -457-

APPENDIX 17
(Continued)

BK Descendants’ Burton, Naomi, & JSK 1st Trust #2
Trust all of the descen- JSK 2d Trust #2
dants of the JSK 3d Trust #2
grantor’s son
living from time
to time

BK Grand- Burton, Naomi, & JSK 1st Trust #3
children's Trust Burton’s grand- JSK 2d Trust #3
children living JSK 3d Trust #3
from time to time

Lillian Trust Burton, Naomi, & JSK 2d Trust #20
Lillian Wilsker JSK 3d Trust #20

J-1 Wifes Trust Burton, Joel’s wife JSK 1st Trust #6
& the children of JSK 2d Trust #6
Carl I. Kanter JSK 3d Trust #6
living from time
to time

J-2 Husbands Burton & Janis’s hus- JSK 1st Trust #7
Trust band & the child- JSK 2d Trust #7
ren of Aloysius B. JSK 3d Trust #7
and Helene M.
Osowski

J-3 Wifes Trust Burton, Joshua’s JSK 1st Trust #8
wife & Ruth & JSK 2d Trust #8
Philip Loshin JSK 3d Trust #8

Exhs. 135, 9187, 9269, 9270, 9271.