Hartman v. Comm'r

T.C. Memo. 2009-124

UNITED STATES TAX COURT

LARRY L. HARTMAN, ET AL.,1 Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent2

Docket Nos. 1371-85, 48690-86, Filed June 1, 2009.
4116-87, 15673-87,
16761-87, 18551-88,
29429-88.

Robert Alan Jones and Declan J. O’Donnell, for petitioner

Larry L. Hartman in docket Nos. 1371-85, 4116-87, and 16761-87

and for petitioners Jesse M. and Lura L. Lewis in docket Nos.

15673-87, 18551-88, and 29429-88.

1
Cases of the following petitioners are consolidated
herewith: Wilbert L.F. and Valarie W. Liu, docket No. 48690-86;
Larry L. Hartman, docket Nos. 4116-87 and 16761-87; and Jesse M.
and Lura L. Lewis, docket Nos. 15673-87, 18551-88, and 29429-88.
2
This opinion supplements and amends Hartman v.
Commissioner, T.C. Memo. 2008-124, reconsidering and superseding
Lewis v. Commissioner, T.C. Memo. 2005-205.
 - 2 -

Matthew K. Chung, for petitioners Wilbert L.F. and Valarie

W. Liu in docket No. 48690-86.

Henry E. O’Neill, for respondent.

SUPPLEMENTAL MEMORANDUM OPINION

BEGHE, Judge: Pursuant to Rule 161,3 respondent and

petitioners Larry L. Hartman (Mr. Hartman) and Jesse M. and Lura

L. Lewis (the Lewises) have filed motions for reconsideration of

our prior Memorandum Opinion Hartman v. Commissioner, T.C. Memo.

2008-124 (Hartman I), reconsidering and superseding Lewis v.

Commissioner, T.C. Memo. 2005-205.

Respondent’s motion or motions for reconsideration comprise

four items under two headings: The first and fourth items

concern issues of implementation and timing of the sanction

against respondent that we held in Hartman I would lead to

vacating stipulated decisions in Kersting project cases and

giving taxpayers in those cases the benefit of the “Thompson

settlement”; the second and third items embody respondent’s

objections to the Court’s characterizations of the actions of

respondent’s management in formulating and proffering

respondent’s posttrial settlement offer to Kersting project

3
Unless otherwise indicated, Rule references are to the Tax
Court Rules of Practice and Procedure, and section references are
to the Internal Revenue Code of 1986 as amended.
 - 3 -

petitioners and the Court’s use of evidence in connection

therewith.

The motion of Mr. Hartman and the Lewises for

reconsideration reflects partial agreement with respondent’s

motion or motions regarding implementation of the sanction; their

motion also requests extension of the sanction to Kersting tax

shelter cases that were settled without being docketed in the Tax

Court.

No motion objects to the Court’s overall conclusion that

stipulated decisions should be vacated to allow the taxpayers to

obtain the benefits of the Thompson settlement.

In Hartman I we granted petitioners’ motions to vacate the

decisions entered in their cases, because of the misconduct of

respondent’s attorneys in implementing the test case procedure

used by the Court and the parties in the Kersting tax shelter

project. See Dixon v. Commissioner, T.C. Memo. 1991-614 (Dixon

II), vacated and remanded sub nom. DuFresne v. Commissioner, 26

F.3d 105 (9th Cir. 1994), on remand Dixon v. Commissioner, T.C.

Memo. 1999-101 (Dixon III), supplemented by T.C. Memo. 2000-116

(Dixon IV), revd. and remanded 316 F.3d 1041 (9th Cir. 2003)

(Dixon V), culminating with our disposition of the second remand

in Dixon v. Commissioner, T.C. Memo. 2006-90 (Dixon VI),
 - 4 -

supplemented by T.C. Memo. 2006-190 (Dixon VIII), on appeal (9th

Cir., Dec. 28, 2006, and Jan. 3, 2007).4

In Dixon V the Court of Appeals for the Ninth Circuit held

that the misconduct of the Government attorneys in the test case

proceedings was a fraud on the Tax Court that violated the rights

of all Kersting project petitioners who had agreed to be bound by

the outcome of the test cases to be tried in the Tax Court. As a

sanction against respondent for the misconduct, the Court of

Appeals mandated that “terms equivalent to those provided in the

settlement agreement with * * * [the Thompsons] and the IRS” be

extended to “Appellants [test case petitioners] and all other

taxpayers properly before this Court”. Dixon V at 1047.

In Hartman I, applying the rationale and holding of the

Court of Appeals in Dixon V, we held that the fraud on the Court

committed by respondent’s trial attorney and his supervisor in

the test case proceedings constituted fraud on the Court in every

4
In Dixon v. Commissioner, T.C. Memo. 2006-97 (Dixon VII)
and Young v. Commissioner, T.C. Memo. 2006-189, we responded to
the supplemental mandate of the Court of Appeals for the Ninth
Circuit in Dixon v. Commissioner, 316 F.3d 1041 (9th Cir. 2003)
(Dixon V), revg. T.C. Memo. 1999-101 (Dixon III), to determine
the appellate legal fees to which Kersting project petitioners
and their counsel in Dixon V were entitled. In Dixon v.
Commissioner, 132 T.C. __ (2009) (Dixon IX), and Gridley v.
Commissioner, T.C. Memo. 2009-89, we have acted on motions for
attorney’s fees and expenses incurred in the Dixon V remand
proceedings by or on behalf of petitioners represented by
attorneys of the law firm of Porter & Hedges LLP and by Robert
Alan Jones. Similar motions by petitioners represented by
Michael Lewis Minns and Joe Alfred Izen, Jr., are pending.
 - 5 -

case bound by the outcome of the test cases and that respondent

had an obligation to fully disclose the misconduct, not only to

the Court and the test case petitioners, but also to all

petitioners who had been bound by the outcome of the Kersting

project test cases. We held further that respondent’s posttrial

settlement offer did not adequately disclose the Government

attorneys’ misconduct to the offerees and did not remedy or purge

the fraud from the Kersting project cases. We held that the

sanction mandated by the Court of Appeals in Dixon V should be

imposed in the cases of all Kersting project petitioners in which

stipulated decisions were entered on or after June 10, 1985, the

commencement date of implementing the test case procedure in the

Kersting project. Our reference to Government attorneys in

Hartman I and in this supplemental opinion is to respondent’s

trial counsel and his supervisor, and reference to the fraud on

the Court is to the misconduct of those Government attorneys

throughout the test case proceedings.

We believed that the most efficient way to implement the

sanction would be to allow respondent to adjust administratively

the accounts of all Kersting project petitioners, other than Mr.

Hartman, the Lewises, and petitioners Wilbert L. F. and Valarie

W. Liu (the Lius), without requiring further action from the

Kersting project petitioners. It appeared to the Court that

respondent could make such administrative adjustments as
 - 6 -

evidenced by the fact that, after stipulated decisions became

final in the cases of Kahle v. Commissioner, docket Nos. 24558-84

and 38976-84, respondent administratively had partially abated

Mr. Kahle’s agreed deficiencies by giving him the benefit of the

7-percent reduction in deficiencies provided in respondent’s

posttrial settlement offer. In Hartman I we set forth a

procedure to be implemented after the decisions in these cases

become final that would give respondent 9 months thereafter to

adjust administratively the accounts of all Kersting project

petitioners against whom stipulated decisions had been entered on

or after June 10, 1985.

Background

For purposes of this supplemental opinion, we incorporate

our findings in Hartman I. For convenience and clarity, we

repeat here the facts necessary to understand the discussion that

follows, and we supplement those facts as appropriate.

Respondent determined deficiencies and additions to tax

against petitioners and other taxpayers who participated in tax

shelter programs promoted by Henry F.K. Kersting. Respondent’s

determinations resulted in more than 1,800 cases in this Court

arising from the disallowance of interest deductions claimed by

Kersting program participants. Most petitioners signed

stipulations with respondent that their cases would be resolved
 - 7 -

in accordance with the Court’s opinion and decisions in the test

cases (piggyback agreements).

After the trial of the test cases, the Court issued its

opinion in Dixon II sustaining virtually all of respondent’s

adjustments. After the Court had issued Dixon II and entered

decisions in the test cases, respondent’s management discovered

and disclosed to the Court and counsel for other test case

petitioners that before the test cases were tried respondent’s

trial attorney Kenneth McWade and his supervisor had entered into

secret settlements with test case petitioners John R. and Maydee

Thompson (the Thompsons) and John R. and E. Maria Cravens (the

Cravenses). The Thompson settlement provided for reduction of

more that 60 percent of the Thompsons’ originally determined

deficiencies, as well as elimination of all Kersting-related

penalties and additions, as a means of creating refunds to be

paid to the Thompsons’ counsel for providing the appearance of

independent representation in the trial of the test cases. The

Cravens settlement provided for reduction of about 6 percent of

the Cravenses’ originally determined deficiencies.

In July 1992 respondent’s National Office began in-house

discussions about offering Kersting project petitioners who were

bound by the test cases through piggyback agreements a 7-percent

reduction settlement along the lines of respondent’s pretrial

Kersting project settlement offer. The Department of Justice
 - 8 -

informed respondent’s management that the Department wished to

offer the Kersting project petitioners whose cases were on appeal

the same settlement that the Thompsons had received, estimated to

be a 65-percent reduction in deficiencies (a rough approximation

of the reduction of the Thompsons’ originally determined

deficiencies from $79,293.52 to the $30,000 figure finally agreed

upon). Respondent’s management was opposed to settling the

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

basis was made to the test case petitioners on appeal.

The first draft of the proposed settlement offer explained

that the Tax Court had issued Dixon II disallowing the interest

deductions, imposing additions to tax for negligence under

section 6653 and substantial understatement of tax under section

6661, and finding that the increased interest rate under section

6621(c) applied. The first draft stated that five of the test

case petitioners (Dixon, DuFresne, Hongsermeier, Owens, and

Young) were appealing their cases in the Ninth Circuit, but that

the appeals had not yet been resolved. The first draft further

stated that respondent had moved to vacate the decisions in the

Cravens, Rina, and Thompson test cases because settlement

agreements had been reached with the Cravenses and the Thompsons,

who were test case petitioners, before the test cases were tried.

The first draft stated that the Tax Court had (1) granted motions

to vacate the decisions in the Thompson and Cravens cases, (2)
 - 9 -

entered agreed decisions in the Cravens cases reflecting the

Cravenses’ pretrial acceptance of the standard Kersting

settlement offer, (3) in the Thompson cases, where the parties

were unable to agree on the decisions, entered decisions

requested by the Thompsons, and (4) denied a motion to vacate the

decision in the Rina case because the testimony and evidence

offered by Thompson and Cravens had no material effect on Dixon

II as it related to Rina and therefore the Court’s findings,

analyses, and conclusions relating to Rina would remain the same.

The first draft stated that the Internal Revenue Service (IRS)

believed that the Court’s disallowance of interest deductions and

the imposition of the additions to tax would be upheld on appeal.

The first draft then stated that the IRS had decided to renew its

previous offer of the 7-percent settlement including the

“burnout”5 and enclosed a form on which the taxpayer could

indicate his/her acceptance of the offer. The first draft stated

5
The burnout was a change, beneficial to taxpayers, adopted
by respondent’s trial attorney in giving effect to respondent’s
pretrial settlement offer for the Kersting project. The burnout
applied in cases involving more than 1 tax year. Under the
burnout, the interest on a taxpayer’s total unpaid
Kersting-related deficiencies for the first and second years of
tax liability would not begin to accrue until the return due date
for the second year. This was accomplished by zeroing out the
taxpayer’s agreed deficiency for the first year and adding it to
the agreed deficiency for the second year. The burnout thus
postponed for a year the accrual of interest on the first year’s
deficiency, thereby reducing the total interest accrued on the
taxpayer’s Kersting-related deficiencies. Variations of the
burnout were used in cases involving more than 2 tax years.
 - 10 -

that the offer applied only to adjustments resulting from

participation in the Kersting programs and that any other

adjustments raised in the case would be settled or litigated item

by item.

A second shorter draft of a settlement proposal gave much

less detail than the first draft. The second draft (1) referred

to the Tax Court’s decision but did not name the case or cite

Dixon II, (2) identified the Cravens case as one of two test

cases in which “some irregular and undisclosed agreements” had

been reached, (3) stated that the Tax Court had concluded that

the outcome of the trial was unaffected by the irregular activity

and that decisions had been entered in the two test cases

enforcing the undisclosed agreements, and (4) did not identify

any of the other test cases or mention that some of test cases

were being appealed. The second draft stated:

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

* * * * * * *

We have determined that the Cravens [sic] in good faith
believed that they had a valid settlement agreement
prior to the trial. Because they were not represented
by counsel, they could not be expected to have detected
any irregularity on our part. Because the Cravens
[sic] received the benefit of this offer even after
trial, we believe that fundamental fairness compels
that you should receive the same treatment. Therefore,
we will apply the benefits of that treatment to your
case.
 - 11 -

The second draft stated that the adjustments to the taxpayer’s

account with the IRS would be made administratively and required

no further action by the taxpayer.

A third draft, also less detailed than the first (1) cited

Dixon II, (2) stated that two of the test case petitioners had

entered into settlement agreements that had not been disclosed to

the other test case petitioners or the Tax Court, (3) did not

identify the test case petitioners who had entered into the

undisclosed settlement agreements or any of the test cases other

than citing Dixon II, (4) stated that the Tax Court had concluded

that the outcome of the trial was unaffected by the testimony of

the test case petitioners who had settled their cases and that

“the opinion of the Tax Court, as it affects you, remains

unchanged”, (5) did not disclose that the Dixons and some of the

other test case petitioners had filed appeals with the Court of

Appeals for the Ninth Circuit. The third draft stated that

“fundamental fairness dictates that you be afforded an

opportunity to settle your case on similar grounds”. The third

draft, like the second draft, indicated that if the taxpayer’s

case had been settled, the adjustments would be made

administratively without requiring further action from the

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

taxpayer had 60 days to accept the offer. The third draft stated

that acceptance of the offer would “preclude any further
 - 12 -

challenges or appeal with respect to the merits of the Dixon

opinion as applied to your case(s).”

In January 1993 respondent made mass mailings extending a

global settlement proposal to all known Kersting project non-

test-case petitioners and their counsel (posttrial settlement

offer). The posttrial settlement offer informed the non-test-

case petitioners that the Court had issued its opinion sustaining

all the adjustments and cited Dixon II. It explained that, after

the trial of the test cases:

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

In general, the posttrial settlement offer represented a

revival of the official project settlement that respondent had

offered during 1982-88. It permitted taxpayers to resolve their

cases by agreeing to pay deficiencies that were 7 percent less

than those determined in their deficiency notices. Respondent

would impose no penalties or additions to tax, and taxpayers
 - 13 -

would pay interest only at the generally applicable (i.e., non-

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

settlement offer did not include the burnout. The posttrial

settlement offer further stated: “Acceptance of this settlement

offer will preclude any further challenge or appeal with respect

to the Kersting programs or the merits of the Dixon opinion. Any

other issues involved in this case will be resolved separately.”

Taxpayers were given 60 days within which to accept or reject the

posttrial settlement offer.

Mr. Hartman had settled his cases with respondent, and

stipulated decisions had been entered in his cases in January

1989 before the test cases were tried. The Lewises, through

their counsel, and the Lius, pro sese, accepted respondent’s

posttrial settlement offer, and stipulated decisions were entered

in their cases in March and June 1993, respectively.

In Dixon V at 1046, the Court of Appeals held that the

misconduct of the Government attorneys in the test case

proceedings was a fraud on the Court that violated the rights of

all Kersting project petitioners who had agreed to be bound by

the outcome of the Tax Court proceeding, a fraud on both the

Kersting project petitioners and the Tax Court “plainly designed

to corrupt the legitimacy of the truth-seeking process”. The

Court of Appeals ordered this Court to sanction respondent by

entering decisions in the cases of the remaining test case
 - 14 -

petitioners and other Kersting project petitioners before the

Court of Appeals on terms equivalent to those provided in the

Thompson settlement.

During the Dixon V remand proceedings, in an order issued

October 12, 2004 (the Dixon order), the Court allowed the

taxpayers’ discovery requests for the limited purpose of

ascertaining respondent’s understanding of the origins and nature

of the Thompson settlement. Evidence of the conduct of

respondent’s management after Dixon II was excluded because it

was not relevant to that purpose.

As part of the limitations on discovery in the Dixon V

remand proceedings, the Court took custody of three boxes for in

camera inspection. Two boxes described in item 123 of

respondent’s privilege log consisted of a chronological file of

16 volumes comprising more than 1,200 items and 5,000 pages

created and maintained by respondent’s counsel Henry E. O’Neill.

The three drafts of the posttrial settlement offer were included

in item 123.

After we completed the inspection, we ordered respondent to

produce more than 200 items from the third box (all documents

encompassed by respondent’s privilege log except item 123) as

relevant to the origins and nature of the Thompson settlement.

We denied the taxpayers access to the item 123 materials because

they provided no guidance on the scope of the Thompson settlement
 - 15 -

and were not relevant to the Dixon V remand. In note 2 of the

Dixon order, however, we noted that materials in item 123 raised

questions regarding the adequacy of respondent’s disclosure of

the Government attorneys’ misconduct and that we might require

production of those materials later in connection with motions to

vacate decisions in which stipulated decisions had been entered.

See also Dixon VIII n.9. The Court retained custody of the

materials encompassing item 123 of the privilege log.

In Dixon VI and Dixon VIII we responded to the directions

and primary mandate of the Court of Appeals in Dixon V to

determine how the Thompson settlement would be imposed against

respondent in favor of the test case petitioners and all parties

properly before the Court. Kersting project petitioners filed

notices of appeal of Dixon VI and Dixon VIII in the test cases of

Hongsermeier v. Commissioner, docket No. 29643-86, Young v.

Commissioner, docket Nos. 4201-84, 22783-85, and 30010-85, and

Owens v. Commissioner, docket No. 40159-84, and in the nontest

cases of Rogers v. Commissioner, docket No. 17993-95, Huber v.

Commissioner, docket No. 20119-84, Titcomb v. Commissioner,

docket No. 17992-95, and Adair v. Commissioner, docket Nos.

17642-83, 38965-84, 35608-86, 479-89, and 8070-90 (collectively

the Hongsermeier appeal).

After the Court of Appeals issued Dixon V, petitioners and

others filed motions for leave to file motions to vacate the
 - 16 -

stipulated decisions entered by this Court in their cases.

Petitioners premised their motions to vacate the decisions in

their cases on two grounds. First, petitioners argued that the

decisions in their cases were obtained by fraud on the Court

because, inasmuch as petitioners were bound by the decisions in

the test cases, the fraud committed by the Government attorneys

in the test cases necessarily affected and corrupted their cases,

and their settlement agreements did not address the fraud or

foreclose the imposition of sanctions against respondent for the

fraud. Second, petitioners argued that there was misconduct of

respondent’s management in making the posttrial settlement offer,

that such misconduct constituted a new fraud on the Court or

continued the fraud on the Court determined by the Court of

Appeals in Dixon V, and that respondent obtained the stipulated

decisions through that misconduct.

In Lewis v. Commissioner, T.C. Memo. 2005-205, we focused on

the legal consequences of the Lewises’ acceptance of respondent’s

posttrial settlement offer, applying general principles of

contract law. We denied the Lewises’ motions for leave to file

motions to vacate their stipulated decisions on the grounds that

they and their counsel had become aware of the Government

attorneys’ misconduct and of the pending appeals by test case

petitioners when they stipulated the decisions.
 - 17 -

The Lewises filed motions for reconsideration, which we

granted because we had come to believe that in Lewis we had

applied the wrong law, as the Court of Appeals in Dixon V held we

had in Dixon III and Dixon IV, and that we failed to appreciate

and apply the full scope of the holding of Dixon V in accordance

with its rationale. We also granted the motions for leave to

file motions to vacate decisions in the Lewis, Hartman, and Liu

cases. We consolidated the cases because they would all be

appealable to the Court of Appeals for the Ninth Circuit.

When we granted petitioners leave to file motions to vacate

the decisions in these cases we thought that further proceedings

might be necessary to decide whether respondent’s conduct

following the trial of the test cases constituted a fraud on the

Court warranting additional sanctions against respondent. We

ordered respondent to show cause in writing why the matter should

not be set for evidentiary hearing.

Respondent filed a response to the Court’s order to show

cause, opposing the scheduling of an evidentiary hearing on this

matter; respondent took the position that the Court had before it

the entire evidentiary record in Dixon III and Dixon VI upon

which to decide the merits of the motions to vacate. Respondent

asserted that petitioners’ motions could be decided on the Dixon

VI record and that another evidentiary hearing would yield only a
 - 18 -

rehash of the evidence already before the Court and unnecessarily

delay bringing the Kersting project to a close.

In considering the parties’ positions regarding further

discovery and an evidentiary hearing, we took counsel from the

Court of Appeals in Dixon V at 1047, where it said:

“Enormous amounts of time and judicial resources have been

wasted. * * * The taxpayers should not be forced to endure

another trial and the IRS should be sanctioned for this extreme

misconduct.” We believed that another hearing, including full

discovery, in these cases should be avoided if possible.

In an order of the Court dated October 31, 2006 (the October

31 order), we informed the parties that we had considered

petitioners’ arguments and agreed that the Court of Appeals in

Dixon V has determined that the fraud the Government attorneys

committed on the Court in the test case proceedings affected and

corrupted every case that was bound by Dixon II, whether by

piggyback agreement or otherwise. However, a holding to that

effect alone would not resolve the pending motions. We expressed

concern that respondent’s current counsel and some of

petitioners’ counsel would be witnesses and would have to

withdraw from the proceedings if an evidentiary hearing were

necessary. We asked the parties to address whether petitioners’

motions could be decided without a hearing and posed several

questions to the parties, including:
 - 19 -

1. Once the Government trial attorneys had committed fraud

on the Court, could respondent “purge” the fraud from any cases

bound by the test cases and, if so, what action was respondent

required to take in order to do so?

2. Did respondent have a duty to notify petitioners, fully

disclose the misconduct to them, and inform them that Dixon II

was being appealed and the taxpayers were asserting fraud on the

Court? By holding that the remedy for the fraud on the Court was

to entitle all Kersting project petitioners with open cases to

the benefits of the Thompson settlement, did the Court of Appeals

in effect require the IRS to make the same disclosure to the

Kersting project petitioners that this Court had required the IRS

to make in Fisher v. Commissioner, T.C. Memo. 1994-434?

3. When making the posttrial settlement offer, did

respondent continue the fraud on the Court or commit a new fraud

by failing to disclose fully to petitioners the Government

attorneys’ misconduct in the test case proceedings and the

taxpayers’ allegations, on appeal, of fraud on the Court?

4. If such disclosures were required, did respondent’s

filing with the Court of the stipulated decisions obtained

without the disclosures constitute a fraud on the Court? See

e.g., Toscano v. Commissioner, 441 F.2d 930, 935 (9th Cir. 1971)

(“the original fraud was not upon the Tax Court * * * When * * *

Toscano petitioned the Tax Court for redetermination, he carried
 - 20 -

the fraud into the Tax Court. Thus he was continuing to defraud

the Commissioner * * * But he was doing more; he was also

perpetrating a fraud upon the Tax Court”), vacating 52 T.C. 295

(1969). Did respondent have an obligation to file the form of

settlement offer letter with the Tax Court when he asked the

Court to enter the stipulated decisions obtained through that

offer?

5. Was our holding in Lewis v. Commissioner, T.C. Memo.

2005-205, analogous to requiring taxpayers to show prejudice as a

result of the misconduct such that, under the holding of Dixon V,

we applied the wrong law?

6. Respondent acknowledged that Kersting project

petitioners whose stipulated decisions were procured and entered

after the publication of Dixon II and before the discovery and

disclosure to the Court of the misconduct of respondent’s

attorneys are entitled to have their decisions vacated, thereby

conceding that stipulated decisions should be vacated because of

fraud on the Court. Are stipulated decisions entered before the

publication of Dixon II also subject to being vacated for fraud

on the Court? Were petitioners who settled their cases before

the publication of Dixon II entitled in so doing to assume that

the test cases would be tried properly?

We stated that we believed that the answers to the questions

might eliminate the need for a hearing to establish facts
 - 21 -

concerning the posttrial conduct of respondent’s management. The

Court sought the views of the parties and their counsel on the

questions posed and ordered petitioners and respondent to file

responses to the order addressing the Court’s questions with

legal reasoning and citations and discussions of legal

authorities to support their views.

In the October 31 order we also quoted the posttrial

settlement offer that led to most of the stipulated decisions

that petitioners sought to vacate and commented on material facts

that had been omitted. We stated that there was no need to hold

an evidentiary hearing to conclude that in a number of respects

respondent’s settlement offer constituted less than full

disclosure and was misleading.

In the October 31 order we also pointed out that evidence of

alleged continuing misconduct by respondent’s management and

representatives following the trial of the test cases had been

excluded from all evidentiary hearings. We specifically noted

our prior Dixon order and stated: “Footnote 2 of the Dixon order

clearly indicates that the Court believed that item 123 was

relevant to allegations of respondent’s misconduct raised by

petitioners in the pending motions.”

In an order dated November 15, 2006 (the November 15 order),

we posed an additional question, arising from respondent’s

concession in Kahle v. Commissioner, docket Nos. 24558-84 and
 - 22 -

38976-84, where the stipulated decisions entered in the cases had

been negotiated after the trial of the test cases, been executed

after Dixon II was issued, and become final before respondent

discovered and disclosed to the Court the misconduct of the

Government attorneys. In response to an earlier order to show

cause, respondent stated that respondent did not oppose vacating

the stipulated decisions entered in the Kahle cases, conceding

that the decisions in those Kahle cases were arguably obtained by

a fraud on the Court. In the November 15 order, the Court

ordered petitioners and respondent to address the implications of

that concession insofar as it affected stipulated decisions that

were entered and/or became final before the Cravenses and the

Thompsons settled their cases, (2) after the Cravenses and the

Thompsons settled their cases but before the trial of the test

cases, and (3) after the trial of the test cases but before

publication of Dixon II.

The parties timely filed their responses to the October 31

and November 15 orders. Although respondent and petitioners took

opposing positions on every question, we still wished to avoid

another expensive and lengthy hearing that might require

respondent’s and petitioners’ counsel to withdraw.

After considering the parties’ positions, we concluded that

admitting into evidence the three drafts of the posttrial

settlement offer, which spoke for themselves, would eliminate the
 - 23 -

need for a hearing. Because we had indicated to respondent in

the Dixon order and the October 31 order that documents in item

123 were relevant to the issues in these cases, we ordered that

the three drafts of the posttrial settlement offer be marked for

identification and received into evidence in these cases as the

Court’s Exhibits 1-A, 2-B, and 3-C.

In Hartman I we held that the fraud on the Court committed

by the Government attorneys in the test case proceedings was a

fraud on the Court in all cases bound by the outcome of the test

cases and granted the motions to vacate filed by the Lewises, Mr.

Hartman, and the Lius. We held further that all Kersting project

petitioners against whom stipulated decisions were entered on or

after June 10, 1985, are entitled to the benefits of the Thompson

settlement, thereby imposing on respondent in all Kersting

project cases the sanctions mandated by the Court of Appeals in

Dixon V. We concluded Hartman I by describing a procedure for

implementing our holding.

Respondent moves the Court to reconsider Hartman I in the

following respects, which we have regrouped to reflect the order

in which we will address them: (1) Reverse all factual findings

that were based on item 123 concerning communication of the

posttrial settlement offer, (2) strike from the Court’s opinion

findings of continuing fraud on the Court beyond the original

misconduct of the Government attorneys in the test case
 - 24 -

proceedings, (3) delay implementation of any sanctions in these

cases until after the Court of Appeals issues its mandate in the

Hongsermeier appeal (the Hongsermeier mandate), and (4)

substitute respondent’s alternative plan for implementing the

sanction.

Petitioners move the Court to reconsider the method of

implementing the sanctions and to extend the sanction to

participants in the Kersting tax shelters who never filed a

petition in the Tax Court to contest the deficiencies determined

against them.

Discussion

The granting of a motion for reconsideration rests within

the Court’s discretion. Estate of Quick v. Commissioner, 110

T.C. 440, 441 (1998); see Lucky Stores, Inc. & Subs. v.

Commissioner, T.C. Memo. 1997-70, affd. 153 F.3d 964 (9th Cir.

1998). A motion for reconsideration will be denied absent a

showing of unusual circumstances or substantial error. Estate of

Quick v. Commissioner, supra; Alexander v. Commissioner, 95 T.C.

467, 469 (1990), affd. without published opinion sub nom. Stell

v. Commissioner, 999 F.2d 544 (9th Cir. 1993).

I. Findings Concerning Formulation and Communication of
Posttrial Settlement Offer

Respondent moves the Court to reconsider Hartman I to

reverse all factual findings that were based on item 123

concerning formulation and communication of the posttrial
 - 25 -

settlement offer. Respondent asserts that the Court’s actions in

making drafts of the pretrial settlement offer part of the record

without allowing respondent an opportunity to challenge the

evidence or present evidence in opposition are inconsistent with

due process and the fundamental rights of litigants.

The three drafts of the proposed posttrial settlement

agreement were documents in respondent’s records and were

received into evidence in these cases as the Court’s Exhibits 1-

A, 2-B, and 3-C. In our view, the progression of the three

drafts of the proposed posttrial settlement agreement included in

item 123 evidenced efforts by respondent’s management to provide

Kersting project petitioners with less rather than more

information. That progression was relevant to (1) our

consideration of whether and to what extent respondent had an

obligation to disclose to non-test-case petitioners the facts

surrounding the Government attorneys’ misconduct during the test

case proceedings, (2) whether respondent’s management misled

petitioners or concealed from them facts concerning the

misconduct of the Government attorneys during the test case

proceedings, and (3) whether the actions taken by respondent’s

management after discovery of the Government attorneys’

misconduct might have mitigated the harm caused by the

misconduct.
 - 26 -

In our view, the mitigating effect of the posttrial

settlement offer could not be properly evaluated without

consideration of the three drafts. The drafts were documents in

respondent’s records subject to discovery that were properly

includable in the record in these cases. We had indicated to

respondent in the Dixon order and the October 31 order that

documents in item 123 were relevant to the issues in the motions

to vacate. Because the drafts speak for themselves, we ordered

them received into evidence as the Court’s exhibits, rather than

setting the matter for a hearing and commencing discovery

procedures. In so doing, we avoided the need for additional

discovery and an evidentiary hearing, which respondent vehemently

opposed. Petitioners, who had requested a hearing, have no

objections to the exhibits.

Respondent’s request that the Court reverse all factual

findings that were based on item 123 on the issue of respondent’s

intent in formulating and communicating the posttrial settlement

offer is denied.

II. Continuing Misconduct Beyond the Fraud on the Court of the
Government Attorneys During the Test Case Proceedings

Petitioners premised their motions to vacate the stipulated

decisions in their cases on two alternative grounds: First, that

those decisions were obtained by fraud on the Court because

petitioners were bound by the decisions in the test cases, the

fraud committed by the Government attorneys in the test cases
 - 27 -

necessarily affected and corrupted their cases, and their

settlement agreements did not address the fraud or foreclose the

imposition of sanctions against respondent for the fraud; second,

that there was misconduct of respondent’s management in making

the posttrial settlement offer, that such misconduct constituted

a new fraud on the Court or continued the fraud on the Court

determined by the Court of Appeals in Dixon V, and that

respondent obtained the stipulated decisions through that

misconduct.

We emphasize that we did not decide Hartman I on the second

ground advanced by petitioners. We would not have done so

without affording respondent’s management a further hearing. We

decided Hartman I on the first ground on the basis of the

existing record in the Dixon cases supplemented with the drafts

of the posttrial settlement offer without further discovery or an

evidentiary hearing. We held that the Government attorneys in

the test case proceedings had committed a fraud on the Court in

every case that was bound by the Kersting project test cases,

under the rationale and holding of the Court of Appeals in Dixon

V. The only fraud committed on the Court was the fraud committed

by respondent’s trial attorneys in the test cases in soliciting,

entering into, and concealing the settlement of the Thompson and

Cravens cases.
 - 28 -

In Hartman I we focused on whether respondent’s posttrial

disclosure and settlement offer could purge from these cases the

fraud committed on the Court by respondent’s trial attorneys or

otherwise rectify the harm caused by the fraud on the Court. We

noted that, once a fraud is committed, subsequent voluntary

disclosure of the fraud does not purge the fraud. Badaracco v.

Commissioner, 464 U.S. 386, 394 (1984). The fraud on the Court

committed by respondent’s attorneys was completed once the test

cases were tried. We held that, regardless of respondent’s

disclosures to the Court, all Kersting project cases that were

bound by the test cases during the test case proceedings remain

cases of fraud on the Court, and respondent remains subject to

sanction for that fraud in every such case.

In deciding whether the sanction mandated by the Court of

Appeals in Dixon V should be applied in the cases of Kersting

project petitioners who accepted respondent’s posttrial

settlement offer, we considered whether respondent’s posttrial

actions mitigated the harm done by the fraud. For that purpose,

we identified respondent’s obligations to such petitioners and

found (1) that respondent was obligated to inform Kersting

project non-test-case petitioners of the existence and terms of

the Thompson settlement and that Dixon II was being appealed and

(2) that respondent intentionally omitted those material facts in

the posttrial settlement offer.
 - 29 -

In the motion for reconsideration respondent argues that

section 6103 prohibited respondent from disclosing the terms of

the Thompson settlement agreement to non-test-case petitioners.

We disagree. Section 6103(h)(4) permits disclosure of return

information in judicial and administrative tax proceedings. The

Thompsons were petitioners (parties) in test cases that

determined their civil tax liabilities, see sec. 6103(h)(4)(A),

and the treatment of the disallowed Kersting deductions claimed

on the Thompsons’ returns was directly related to the resolution

of that issue in every case bound by the outcome of the test

cases. The section 6103(h)(4) exception to nondisclosure

permitted disclosure of the Thompson settlement to petitioners

whose cases were bound by the Thompsons’ cases. Moreover, the

decision documents in the Thompsons’ cases disclosed the

settlement. The decision documents in a Tax Court case are

public records, open for inspection by the public. Respondent

had an obligation to fully disclose the agreement to the non-

test-case petitioners.

In Hartman I we observed that (1) willful concealment or

omission of material facts or intentional statements of

half-truths will support a finding of fraud, (2) respondent,

having disclosed some of the facts concerning the irregularities

in the test case procedure, was obliged to disclose all facts

that would materially qualify the limited facts that were
 - 30 -

disclosed, and (3) the Court has held that a settlement

stipulation may be set aside for excusable, damaging reliance

upon a false or untrue representation of the other party. Again,

we made those observations in deciding whether respondent’s

posttrial settlement offer somehow mitigated the harm done by the

fraud committed by respondent’s attorneys in the test case

proceedings. We did not hold that respondent’s failure to

satisfy respondent’s obligation to inform or omission of material

facts was a fraud on the Court. Nor did we hold or conclude that

respondent’s omissions in formulating and proffering the

posttrial settlement offer evidenced a “scheme of secrecy” to

hide the Thompson settlement; we limited our use of that term,

see Hartman I, slip op. at 119-120, to the concealment of the

Thompson settlement that constituted the fraud on the Court by

respondent’s trial attorney and his supervisor.

We also found that the stipulated decisions and the

posttrial settlement agreement did not specifically release

respondent from liability for matters arising from the

misconduct.

In Hartman I we held that sanctions should be imposed in the

cases of all Kersting project petitioners in which stipulated

decisions were entered on or after June 10, 1985, the date the

Kersting project test case proceedings began, by extending the

benefit of the Thompson settlement to all such petitioners.
 - 31 -

Since we did not find a continuing fraud on the Court beyond

that committed by respondent’s trial counsel during the test case

proceedings, there are no findings to strike from Hartman I.

Respondent’s request is moot.

III. Modification and Delay of Implementation of Sanctions

In Hartman I we recognized that “Enormous amounts of time

and judicial resources have been wasted” and hoped to relieve

other Kersting project non-test-case petitioners who had

stipulated decisions entered in their cases on or after June 10,

1985, of the burden of filing motions for leave to file motions

to vacate decisions. It appeared to the Court that respondent

could adjust administratively such petitioners’ accounts, as had

been done in the Kahle cases after those decisions had become

final. We believed that the most expeditious and efficient means

of implementing the sanction would be to allow respondent to

adjust administratively the accounts of all Kersting project

petitioners, other than Mr. Hartman, the Lewises, and the Lius,

without requiring further action from the Kersting project

petitioners.

To facilitate the implementation of the sanction, we

proposed to issue an order (the implementation order) directing

respondent to send a copy of Hartman I and the implementation

order to all taxpayers who had filed petitions in this Court

contesting the adjustments at issue in Dixon II and who had
 - 32 -

stipulated decisions entered in their cases (closed cases) on or

after June 10, 1985. That notification action by respondent was

to be completed within 60 days after the decisions entered in

these cases become final, i.e., after the Court of Appeals for

the Ninth Circuit renders its decision, if and when the decisions

herein should be appealed. Respondent would have 9 months after

the date the decisions in these cases become final to adjust

administratively the accounts of all Kersting project petitioners

who had stipulated decisions entered in their cases on or after

June 10, 1985.

Respondent asks the Court to delay entry of decisions in

these cases and the implementation of sanctions in the closed

cases until the Court of Appeals for the Ninth Circuit has issued

the Hongsermeier mandate and to modify the implementation of

sanctions.

We first address respondent’s request that we delay

implementation of the sanctions.

A. Delay of Entry of Decisions in the Hartman, Lewis, and
Liu Cases

Respondent first requests that the Court delay entry of

decisions in these cases, the Hartman, Lewis, and Liu cases,

until after the Court of Appeals issues the Hongsermeier mandate.

We held in Hartman I that the administrative adjustment

procedure would not be implemented until the decisions in these

cases are final. These cases will not become final until any
 - 33 -

appeal by petitioners or respondent is complete, presumably after

or simultaneously when the Court of Appeals issues the

Hongsermeier mandate. We do not believe the decisions in these

cases should be postponed; a postponement would unnecessarily

delay any appeal in one or more of these cases. The Court will

order decisions in these cases to be submitted under Rule 155

within 30 days after the filing of this supplemental opinion. If

respondent and petitioners in any of these cases agree that

neither party will file an appeal in the case and that both

parties want to delay entry of decision until after the Court of

Appeals has decided the appeal of any of the other of these

consolidated cases and the Hongsermeier appeal, the Court will

extend the date for filing the Rule 155 computation until that

time.

B. Delay of Implementation of Sanctions in Closed Cases
Until After Court of Appeals Has Decided Cases
Currently on Appeal From Dixon VI and Dixon VIII

Implementation of the sanctions in other cases was to begin

by notification from respondent to affected Kersting project

petitioners. The notification was to be completed within 60 days

after the decisions entered in these cases had become final;

i.e., after the Court of Appeals for the Ninth Circuit renders

its decision, if and when the decisions herein should be

appealed. Respondent asks the Court to delay implementation of
 - 34 -

the sanction until after the Court of Appeals has decided the

cases currently on appeal from Dixon VI and Dixon VIII.

In setting the deadlines for implementing the sanction, we

did not expect that the decisions in the cases at hand might

become final before the Court of Appeals decided the Hongsermeier

appeal. Upon reconsideration, we believe that implementation of

sanctions in closed cases other than these cases should not

commence until the later of (1) the last date a decision in any

of these cases become final, (2) the date the Court of Appeals

for the Ninth Circuit renders its mandate in any of these cases,

if and when the decisions herein should be appealed, and (3) the

date of the Hongsermeier mandate.

C. Modification of Implementation of Sanctions

Respondent asks the Court to modify the Court’s method of

implementing the sanction. Respondent, citing section 6512,

argues that the Court “lacks jurisdiction to order overpayment

refunds with respect to closed cases when the final decisions

have not been vacated”. In Hartman I we did not hold that we

would order respondent to make the administrative adjustments--

we held that we would issue the implementation order giving

respondent the opportunity to adjust administratively the

accounts of the petitioners in closed cases before acting on any

motions to vacate decisions in other closed cases or accepting

any new motions in closed cases where motions had not as yet been
 - 35 -

filed. Respondent asserts that the adjustment to Mr. Kahle’s

account in the Kahle cases did not result in a refund of an

overpayment of tax and that section 6512(a) prohibits respondent

from making a refund in the closed cases by adjusting

administratively the accounts of the petitioners in closed cases.6

Respondent argues that the Court has made no determinations

of overpayment of tax with respect to the approximately 800

closed cases and section 6512(a) prohibits respondent from

issuing refunds administratively. Instead, in order for

respondent to comply, the Court must vacate the decisions and

determine the amounts of the overpayments.

To facilitate implementation of the sanction, we shall

issue the following implementation order.

1. Status Reports Identifying Affected Closed Cases

a. On or before 90 days after the date this

supplemental opinion is filed, respondent shall file with the

Court a status report (the first status report) listing all cases

6
If the Commissioner has mailed a notice of deficiency to a
taxpayer for a tax year and the taxpayer has filed a timely
petition with the Court, sec. 6512(a) prohibits the Commissioner
from making a refund or credit for that taxable year except as
to, inter alia, an overpayment determined by a decision of the
Tax Court which has become final. The Court has jurisdiction to
determine the amount of an overpayment of tax for a taxable year,
and the amount so determined by the Court shall, when the
decision of the Court becomes final, be credited or refunded to
the taxpayer. See sec. 6512(b)(1). Sec. 6512(b)(3) limits the
amount of any such credit or refund to the portion the Court
determines was paid after the mailing of the notice of deficiency
or within the applicable look-back period.
 - 36 -

of the petitioners who filed petitions in this Court contesting

the adjustments at issue in Dixon II who had stipulated decisions

entered in their cases on or after June 10, 1985, that became

final before the Court filed Dixon VI and Dixon VIII (the

affected closed cases) by caption and docket number and, if then

known to respondent, the current addresses of the petitioners in

the cases and any counsel of record. In the first status report

respondent shall identify those cases in which respondent agrees

the sanctions may be applied and those in which respondent

contends the sanctions may not be applied with a brief

explanation of respondent’s basis for excluding each case to be

excluded;

b. Respondent shall continue to search for the

current addresses for the petitioners in the affected closed

cases. In each affected closed case where the petitioners were

represented by counsel, respondent shall contact the counsel of

record in an attempt to verify that the representation is

current. On or before 30 days after filing the first status

report, respondent shall file a second status report, providing

the current addresses of those petitioners and the names and

addresses of any counsel of record not provided in the first

status report. Respondent shall submit additional status reports

on respondent’s continuing efforts to identify the petitioners’

current addresses and counsel of record in the affected closed
 - 37 -

cases every 30 days until all addresses and counsel of record

have been identified and provided to the Court;

2. Sanction Notice to Petitioners in Affected Closed
Cases

On or before 60 days after the later of (1) the last date a

decision in any of these cases becomes final, (2) the date the

Court of Appeals for the Ninth Circuit renders its mandate in any

of these cases, if and when the decisions herein should be

appealed, and (3) the date of the Hongsermeier mandate,

respondent shall send a notice to the petitioners in all the

affected closed cases of the imposition of a sanction in cases

bound by the Kersting project test cases (sanction notice). In

the sanction notice, respondent shall:

a. Provide the petitioners with a brief synopsis

of the background and opinions imposing the sanction on

respondent.

b. Rather than providing copies of Hartman I and

this supplemental opinion, provide links to the Opinions search

file on the Court’s Web site.6

c. When possible, respondent shall compute the

proposed adjustments to tax in the petitioners’ case(s) and

inform the petitioners of the result (i.e., the estimated amount

of overpayment or balance due).

6
For example, the link to Hartman I is
http://www.ustaxcourt.gov/InOpHistoric/Hartm8an.TCM.WPD.pdf.
 - 38 -

d. Inform the petitioners that the sanction need

not be applied in their case if it would be detrimental to them.

e. Inform the petitioners that, if they wish to

have the sanction applied in their case, respondent will file

with the Tax Court a motion for leave to file a motion to vacate

the decision(s) in their case(s) and a motion to vacate the

decision(s).

f. Request that the petitioners inform respondent

within 60 days of their decisions either to have the sanction

applied in their case or to waive the sanction.

g. Include the name of IRS contact personnel who

can answer any questions the petitioners may have concerning the

imposition of the sanction in their cases.

3. Status Reports on Responses to Sanction Notice

On or before 90 days after respondent sends the sanction

notice to the petitioners in the affected closed cases,

respondent will file a status report with the Court reporting on

the responses received, listing those case in which sanctions are

expected to be applied, those in which the petitioners waived

application of the sanctions, and those in which no response was

received. Respondent shall attach to the status report for the

Court’s records all responses where the petitioners waived the

sanction and requested that it not be applied to their cases.
 - 39 -

D. Motions for Leave To File Motions To Vacate Decisions
in Affected Closed Cases

In each case in which the petitioners have requested that

the sanction be applied in their affected closed case, respondent

shall file a motion for leave to file a motion to vacate the

decision in the case and a motion to vacate the decision.

Respondent shall attach the petitioners’ request to the motion

for leave. Upon receipt of the motion, the Court will grant the

motion and order the decision in the case vacated.

The parties shall work expeditiously to prepare and execute

new decisions (and overpayment stipulations, as appropriate)

reflecting the revised liabilities after application of the

Thompson settlement and, within 90 days after the order to

vacate, shall submit the new decision for the Court’s review and

entry. If the parties are unable to reach agreement with respect

to the new decision documents, the parties will submit their

respective positions to the Court for resolution within 120 days

of the order to vacate.7 See Rule 155.

In addition to motions filed in these cases, motions for

leave to file motions to vacate stipulated decisions have been

filed in 66 other affected closed cases. In Hartman I we held

that we would not act on those motions, so that respondent could

7
Respondent cautions that disputes might arise if the
existing records are incomplete, creating uncertainty as to the
computation of the revised deficiencies and/or payment history.
 - 40 -

have an opportunity to adjust the accounts administratively.

Because respondent cannot adjust the accounts administratively

and the Court must vacate the decisions in the affected closed

cases, the Court will grant leave to file the motions to vacate

decisions in cases where motions for leave have been filed and

will accept for filing and grant any motions for leave to file

motions to vacate the decisions in other affected closed cases.

E. Cases That Will Remain Closed

The Court will not take any action in any cases in which

the petitioners either did not respond or sent a negative

response; those cases will remain closed.

IV. Petitioners’ Motion

In Hartman I we held that the fraud on the Court committed

by respondent’s attorneys in the Kersting project test cases

violated the rights not only of the test case petitioners but of

every petitioner whose case was bound by the outcome of the test

cases. The fraud committed by the Government attorneys was a

fraud on the Court in every one of the more than 1,800 Kersting

project cases filed in this Court. Extending the benefit of the

Thompson settlement to all Kersting project petitioners who were

part of the Kersting project test case procedure is the sanction

that in Dixon V the Court of Appeals deemed appropriate and

necessary to restore the confidence of future litigants who may

become involved in test case proceedings. In Hartman I we held
 - 41 -

that the Dixon V sanction should be applied to give the same

relief to all Kersting project petitioners whose cases were part

of the Kersting project test case proceedings.

In petitioners’ motion for reconsideration, petitioners’

counsel, in essence, ask the Court to extend the sanction to

taxpayers who participated in the Kersting tax shelters and had

deficiencies arising from the disallowance of their claimed

deductions and who either never filed a petition in this Court or

filed a petition in this Court but settled their cases before the

test case proceedings began. We cannot do so because (1) the

fraud committed on the Court did not extend the time for filing a

petition after a notice of deficiency had been issued, and the

Court never acquired jurisdiction over those taxpayers or their

deficiencies, (2) a taxpayer who did not file a petition in this

Court did not have a case in this Court to which the fraud on the

Court committed by the Government attorneys in the test case

proceeding could have attached, (3) the Court invoked its

inherent power to impose a sanction against respondent for the

harm done to the judicial process, namely the test case

proceedings in this Court, which did not involve taxpayers who

were not part of those proceedings, and (5) the Court’s inherent

power is limited to imposing the sanction in those cases in which

a fraud on the Court was committed and does not extend to cases

in which no fraud was committed--i.e., those cases that settled
 - 42 -

before the test case proceedings began--or where there was no

case.

Petitioners’ motion for reconsideration will be denied.

To give effect to the foregoing,

Appropriate orders will be

issued, and decisions will be

entered under Rule 155.