                         T.C. Memo. 2008-124



                       UNITED STATES TAX COURT



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



     Docket Nos.    1371-85,   48690-86,   Filed May 1, 2008.
                    4116-87,   15673-87,
                   16761-87,   18551-88,
                   29429-88.



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


     1
      Cases of the following petitioners are consolidated
herewith: Wilbert L. F. and Valarie W. Liu, docket No. 48690-86;
and Jesse M. and Lura L. Lewis, docket Nos. 15673-87, 18551-88,
and 29429-88.
     *
      This opinion reconsiders and supersedes our previously
filed Memorandum Opinion Lewis v. Commissioner, T.C. Memo. 2005-
205.
                         - 2 -

Commissioner, T.C. Memo. 1999-101 (Dixon III),
supplemented by T.C. Memo. 2000-116 (Dixon IV), revd.
and remanded 316 F.3d 1041, 1047 (9th Cir. 2003) (Dixon
V), on remand T.C. Memo. 2006-90 (Dixon VI),
supplemented by T.C. Memo. 2006-190 (Dixon VIII) (on
appeal).

     In Dixon V, the Court of Appeals for the Ninth
Circuit held that the misconduct of M (R’s trial
attorney) and S (M’s supervising attorney) in arranging
secret settlements with test case petitioners the Ts
and the Cs was a fraud on the Tax Court. The Court of
Appeals observed that the fraud not only violated the
rights of the other test case petitioners and
petitioners in more than 1,300 cases bound by the
outcome of the test cases but also defiled the sanctity
of the Court and the confidence of all future
litigants. The Court of Appeals ordered the Tax Court
to sanction R by entering judgments in favor of the
remaining test case petitioners and other petitioners
in the Kersting tax shelter group before the Court of
Appeals, on terms equivalent to those provided in the
Ts’ secret settlement agreement. The Court of Appeals
left the fashioning of such judgments to the discretion
of the Tax Court.

     Shortly before the trial of the test cases that
resulted in the Tax Court’s opinion in Dixon II, P1
settled his cases on terms more favorable to him than
R’s project settlement offer but less favorable to him
than the Ts’ settlement, and stipulated decisions were
entered in P1’s cases.

      After the trial, Dixon II opinion, and entry of
decisions in the test cases, R’s management discovered
the misconduct of M and S when M attempted to have R
assess deficiencies in the Ts’ and the Cs’ cases in
accordance with the secret settlements rather than with
the Court’s decisions in those cases. In motions to
vacate the decisions entered in the cases of the Ts,
the Cs, and a third test case petitioner, R disclosed
to the Court the misconduct of M and S. R concedes
that stipulated decisions in Kersting project nontest
cases entered after the Court filed its Dixon II
opinion and before R disclosed the misconduct of M and
S to the Court should be vacated.
                         - 3 -

     While the remaining test cases were on appeal, R
reinstated R’s Kersting project settlement offer by
means of an offer letter that contained material
omissions. The offer letter stated: “Acceptance of
this settlement offer will preclude any further
challenge or appeal with respect to the Kersting
programs or the merits of the Dixon opinion. Any other
issues involved in this case will be resolved
separately.” P2s (proceeding pro sese at the time) and
P3s (represented by counsel) accepted R’s offer, and
stipulated decisions were entered in their cases.
Other Kersting project petitioners accepted the
reinstated project settlement offer; as a result,
stipulated decisions were entered in more than 400
cases.

     The stipulated decisions entered in Ps’ cases were
not appealable and became final many years ago. Ps now
seek to have their decisions vacated so that the
sanctions mandated by the Court of Appeals in Dixon V
can be imposed on R in their cases. Ps argue that,
because they were bound by the decisions in the test
cases, the fraud committed by M and S in the test cases
necessarily adversely affected their cases. They ask
this Court to impose on R the same sanctions mandated
by the Court of Appeals in Dixon V for the fraud on the
Court of M and S in the test cases which, they assert,
is imputed to their cases.

     In Lewis v. Commissioner, T.C. Memo. 2005-205, we
denied the motions of P3s for leave to file motions to
vacate their stipulated decisions on the grounds they
and their counsel had become aware of the misconduct of
R’s attorneys and of the pending appeals by test case
petitioners when they agreed to the decisions. P3s
filed a motion for reconsideration asking us to
reconsider our Lewis opinion on the ground that their
settlement agreements did not encompass or foreclose
imposing sanctions on R for the fraud M and S committed
on the Court. We granted the motion for
reconsideration, granted the motions for leave filed by
P1, P2s, and P3s, and consolidated the three sets of
cases for purposes of this opinion. Upon
reconsideration, we hold that the law of the case set
forth in Dixon V requires that Ps’ motions to vacate
stipulated decisions be granted and that all Kersting
project petitioners whose cases were bound by the test
                         - 4 -

cases and who suffered entry of stipulated decisions
are entitled to the benefit of the T settlement.

     1. Held: The fraud on the Court committed by R’s
attorneys in the test case proceedings constituted
fraud on the Court in every case bound by the outcome
of the test cases and harmed the integrity of the
judicial process, not only as the test case procedure
was employed in the Kersting project cases, but also as
it might be employed in the future.

     2. Held, further, imposing the sanctions against
R in every case that was part of the Kersting tax
shelter project is the appropriate sanction for the
fraud committed in the test case proceedings because it
serves to remedy the harm done to the judicial process,
restore public confidence in the test case procedure,
and rectify the violation of the rights of every
petitioner bound by the outcome of the test cases.

     3. Held, further, once R    discovered the
misconduct of R’s attorneys, R   had an obligation to
fully disclose the misconduct,   not only to the Court
and the test case petitioners,   but also to all
petitioners who had been bound   by the outcome of the
Kersting project test cases.

     4. Held, further, R’s posttrial settlement offer
did not adequately disclose R’s attorneys’ misconduct
to the offerees and did not remedy or purge the fraud
from the Kersting project cases.

     5. Held, further, P2s’ and P3s’ requests that
sanctions be imposed on R for the fraud committed on
the Court are not a “challenge or appeal with respect
to the Kersting programs or the merits of the Dixon
opinion” encompassed by R’s posttrial settlement offer,
but rather encompass another issue in their cases that
is to “be resolved separately” under the specific terms
of that offer.

     6. Held, further, the posttrial and other
settlements and stipulated decisions entered in the
cases at hand and in other Kersting project cases do
not divest the Tax Court of its inherent power to
impose sanctions against R for the fraud committed on
the Court in those cases. See, e.g., Bader v. Itel
Corp. (In re Itel Secs. Litig.), 791 F.2d 672 (9th Cir.
                                 - 5 -

     1986) (party cannot avoid sanctions for committing
     fraud on the court by settlement or withdrawing from
     the case).

          7. Held, further, the Tax Court has inherent
     power to impose sanctions against R for the fraud
     committed on the Court in every case that was part of
     the Kersting tax shelter project and may impose such
     sanctions either by vacating the decision in each such
     case and entering a new decision or by separate order
     imposing an equivalent monetary sanction. In the cases
     at hand, we are vacating the decisions.

          8. Held, further, once the new decisions in these
     cases become final, the Court will issue an
     implementation order to allow R reasonable time to
     notify all remaining Kersting project petitioners
     against whom stipulated decisions were entered and to
     adjust their accounts administratively in accordance
     with the terms of the Ts’ settlement. The Court will
     not accept for filing motions for leave to file motions
     to vacate the decisions in the cases of other such
     Kersting project petitioners unless R fails to adjust
     their accounts administratively within 9 months after
     the date of entry of the implementation order.



     Robert Alan 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.

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

W. Liu in docket No. 48690-86.

     Henry E. O’Neill, for respondent.
                                      - 6 -

                                  CONTENTS

                                                                       Page

Introduction       . . . . . . . . . . . . . . . . . . . . . . . . . 8

Background      . . . . . . . . . . . . . . . . . . . . . . . . .        14

     I.    The Kersting Project Test Case Proceedings        . . . .     15

     II.   Respondent’s Discovery and Disclosure of the
           Thompson and Cravens Settlements . . . . . . . . .            32

     III. Kersting’s Responses to Dixon II and Discovery and
          Disclosure of the Secret Settlements: Letters to
          Kersting Program Participants and Formation of the
          Kersting Defense Group . . . . . . . . . . . . . .             41

     IV.     Respondent’s Posttrial Settlement Offer       . . . . .     44

     V.      The Lewis and Liu Settlements . . . . . . . . . . .         49

     VI.     Disciplinary Actions Against McWade and Sims      . . .     50

     VII. Appeals to the Court of Appeals for the Ninth
          Circuit and Proceedings on Remand . . . . . . . . .            52

             A.     Ninth Circuit Remand: DuFresne v.
                    Commissioner and Adair v. Commissioner . . . .       53

           B.       Evidentiary Hearing and Opinions on DuFresne
                    Remand: Dixon III and IV . . . . . . . . . .         55

           C.       Gridley v. Commissioner   . . . . . . . . . . .      62

             D.     Dixon V: Court of Appeals Again Reverses and
                    Remands . . . . . . . . . . . . . . . . . . .        63

             E.     Responses to Dixon V by the Office of Chief
                    Counsel . . . . . . . . . . . . . . . . . . .        66

             F.     Determination on Remand of Terms of the
                    Thompson Settlement by Dixon VI and VIII     . .     68

     VIII.        Motions To Vacate    . . . . . . . . . . . . . . .     72

Discussion        . . . . . . . . . . . . . . . . . . . . . . . . .      74
                                  - 7 -

     I.    Preliminary Comments     . . . . . . . . . . . . . . .   74

     II.     Analysis   . . . . . . . . . . . . . . . . . . . . .   83

             A.   The Fraud on the Court Committed by
                  Respondent’s Attorneys, the Harm Done
                  Thereby, and the Sanction Mandated by the
                  Court of Appeals . . . . . . . . . . . . . . .    84

             B.   Lewis v. Commissioner Reconsidered and
                  Superseded . . . . . . . . . . . . . . . . . .    94

           C.     Subsequent Voluntary Disclosure of the Fraud
                  on the Court Does Not Purge the Fraud . . . .     99

           D.     Respondent’s Posttrial Settlement Offer Did
                  Not Satisfy Respondent’s Obligations to the
                  Nontest Case Petitioners . . . . . . . . . . . 101

           E.     Respondent’s Posttrial Settlement Offer Did
                  Not Rectify the Harm and Does Not Preclude
                  Additional Sanctions . . . . . . . . . . . . . 110

Conclusion      . . . . . . . . . . . . . . . . . . . . . . . . . 127

Implementation of Sanction     . . . . . . . . . . . . . . . . . 130

APPENDIX A      . . . . . . . . . . . . . . . . . . . . . . . . . 134

APPENDIX B      . . . . . . . . . . . . . . . . . . . . . . . . . 136
                               - 8 -

                        MEMORANDUM OPINION


     BEGHE, Judge:   These consolidated cases are before the Court

on petitioners’ motions under Rule 1622 to vacate stipulated

decisions entered many years ago.   Petitioners’ cases are broadly

representative of hundreds of cases in which stipulated decisions

were entered and of dozens of such cases in which motions for

leave to file motions to vacate stipulated decisions have been

filed.

                           Introduction

     Petitioners’ motions arise from the misconduct of

respondent’s attorneys in implementing the Court’s test case

procedure used by the Court in the Kersting tax shelter project

to try and decide Dixon v. Commissioner, T.C. Memo. 1991-614

(Dixon II), vacated and remanded sub nom. DuFresne v.

Commissioner, 26 F.3d 105 (9th Cir. 1994), on remand Dixon v.

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

T.C. Memo. 2000-116 (Dixon IV), revd. and remanded 316 F.3d 1041

(9th Cir. 2003) (Dixon V), culminating with our disposition of

the second remand in Dixon v. Commissioner, T.C. Memo. 2006-90

(Dixon VI), supplemented by T.C. Memo. 2006-190 (Dixon VIII).3     We

     2
      Unless otherwise indicated, all Rule references are to the
Tax Court Rules of Practice and Procedure, and all section
references are to the Internal Revenue Code.
     3
      In Dixon v. Commissioner, T.C. Memo. 2006-97 (Dixon VII)
and Young v. Commissioner, T.C. Memo. 2006-189, we responded to
                                                    (continued...)
                               - 9 -

have entered decisions in the 27 docketed cases that participated

in the second remand; 13 of those cases are on appeal to the

Court of Appeals for the Ninth Circuit,4 where, we assume, they

will be considered by the panel that decided Dixon V.5

     In Dixon V, the Court of Appeals held that the misconduct of

respondent’s trial attorney and his supervisor was a fraud on the

Court that violated the rights of all Kersting project

petitioners who had agreed to be bound by the outcome of the Tax

Court proceeding.   The Court of Appeals ordered this Court to

sanction respondent by entering decisions in the cases of the

remaining test case petitioners and other Kersting project



     3
      (...continued)
the supplemental mandate of the Court of Appeals for the Ninth
Circuit in Dixon v. Commissioner, 316 F.3d 1041 (9th Cir. 2003)
(Dixon V), revg. T.C. Memo. 1999-101 (Dixon III), to determine
the appellate legal fees to which Kersting project petitioners
and their counsel in Dixon V were entitled. We have currently
under consideration motions by various Kersting project taxpayers
and their counsel for awards of fees and expenses for services
rendered in the Dixon V remand proceedings in this Court.
     4
      On July 6, 2007, Kersting project petitioners filed a
notice of appeal in Hongsermeier v. Commissioner, docket No.
29643-86, a test case. On Sept. 10, 2007, Kersting project
petitioners filed notices of appeal in Rogers v. Commissioner,
docket No. 17993-95, Huber v. Commissioner, docket No. 20119-84
and Titcomb v. Commissioner, docket No. 17992-95, all nontest
cases. On Sept. 17, 2007, Kersting project petitioners filed
notices of appeal in test cases Young v. Commissioner, docket
Nos. 4201-84, 22783-85, and 30010-85, and Owens v. Commissioner,
docket No. 40159-84, and in nontest cases Adair v. Commissioner,
docket Nos. 17642-83, 38965-84, 35608-86, 479-89, and 8070-90.
     5
      The separate mandate of the Dixon V panel on appellate
legal fees concluded: “The panel retains jurisdiction over all
further proceedings that may arise.”
                               - 10 -

petitioners before the Court of Appeals on terms equivalent to

those provided in the secret Thompson settlement.

     Petitioners signed stipulations to be bound (piggyback

agreements) in which they agreed with respondent that their cases

would be resolved in accordance with the Court’s opinion in the

test cases.6   Before the test cases were tried, respondent’s trial

attorney and his supervisor had entered into secret settlements

with test case petitioners John R. and Maydee Thompson (the

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

Also, before the test cases were tried, petitioner Larry L.

Hartman (Hartman) settled his cases with respondent, and

stipulated decisions were entered in his cases in January 1989.

     After the Court had issued its opinion in Dixon II and

entered decisions in the test cases, respondent’s management

     6
      Although no piggyback agreement signed by petitioner Larry
L. Hartman (Hartman) was filed in docket No. 16761-87, that case
was not set to be tried with the test cases, and he was
effectively bound by the results in the test cases in docket No.
16761-87, as well as in docket Nos. 1371-85 and 4116-87, in which
he had signed piggyback agreements that were filed with the
Court. Normally, petitioners in a tax shelter project who
decline or otherwise fail to sign a piggyback agreement will
either have their cases set for trial with the test cases or,
after the final decisions in the test cases, will be ordered to
show cause why their case should not be decided the same way as
the test cases. See, e.g., Lombardo v. Commissioner, 99 T.C.
342, 343 (1992), affd. on other grounds sub nom. Davies v.
Commissioner, 68 F.3d 1129 (9th Cir. 1995); Dixon VII; Dixon v.
Commissioner, T.C. Memo. 2000-116 (Dixon IV). In Dixon v.
Commissioner, T.C. Memo. 2006-90 (Dixon VI), we held that
Kersting project petitioners who did not sign piggyback
agreements were entitled to the same relief as those who had
signed piggyback agreements. Dixon VI, 91 T.C.M. (CCH) 1086 at
1107, 2006 T.C.M. (RIA) par. 2006-090 at 2006-671.
                               - 11 -

discovered the secret settlements and disclosed them to the

Court.    Following that disclosure, respondent reinstated

respondent’s project settlement offer, which respondent had

previously terminated before the trial that resulted in the

Court’s opinion in Dixon II.    Petitioners Jesse M. and Lura L.

Lewis (the Lewises), through their counsel, and petitioners

Wilbert L. F. and Valarie W. Liu (the Lius), proceeding pro sese,

accepted respondent’s posttrial settlement offer, and stipulated

decisions were entered in their cases in March and June 1993,

respectively.    The decisions in all of petitioners’ cases herein

were entered, and their cases were closed, before the Court of

Appeals for the Ninth Circuit issued its opinion in DuFresne v.

Commissioner, supra, vacating and remanding Dixon II for an

evidentiary hearing to determine the full extent of respondent’s

misconduct and its effect on the decisions in the remaining test

cases under Dixon II, which we did in our opinions in Dixon III

and IV.

     After the opinion of the Court of Appeals in Dixon V,

reversing and remanding Dixon III and IV for entry of decisions

in the remaining test cases in accordance with Dixon V,

petitioners herein at various times in 2004 filed motions for

leave to vacate the stipulated decisions entered by this Court in

their cases.
                              - 12 -

     Petitioners assert that the fraud on the Court perpetrated

by respondent’s trial attorney and his supervisor in the test

cases was a fraud on the Court in their cases because they were

bound by the outcome of the test case proceedings.   Petitioners

ask the Court to vacate the decisions in their cases so that the

Court can impose on respondent in their cases the same sanctions

mandated by the Court of Appeals in Dixon V for

the fraud on the Court in the test cases as they apply to more

than 1,300 pending cases in the Kersting project that did not

settle.7

     In Lewis v. Commissioner, T.C. Memo. 2005-205, we denied the

Lewises’ motions for leave to file motions to vacate their

stipulated decisions on the grounds that they and their counsel

had become aware of the misconduct of respondent’s attorneys and

of the pending appeals by test case petitioners when they

stipulated the decisions.

     The Lewises filed motions for reconsideration, which we

granted.   We also granted the motions for leave in the Lewis,

Hartman, and Liu cases8 in order to consolidate them for purposes

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

of this opinion because they are all appealable to the Court of

Appeals for the Ninth Circuit.   We also chose to consolidate

these cases because they include cases where stipulated decisions

were entered both before the Court filed its Dixon II opinion

(the Hartman decisions) and after respondent discovered

respondent’s attorneys’ misconduct and disclosed it to the Court

and reinstated the 7-percent project settlement offer (the Lewis

and Liu decisions).

     For purposes of these motions, we take judicial notice of

our findings in Dixon III and IV, as modified by Dixon V, VI, and

VIII (the Dixon findings) and supplemented by Lewis v.

Commissioner, supra.   Additional facts concerning earlier drafts

of respondent’s posttrial settlement offer are from copies of the

drafts of the proposed settlement offer admitted into the records

in these cases as the Court’s exhibits.   Otherwise, additional

pertinent facts, as set forth in petitioners’ motions,

respondent’s oppositions thereto, and the parties’ replies to


     8
      (...continued)
the underlying (lodged) motion to vacate decision in order to
determine whether the moving party had alleged sufficient facts
to call into question the validity of the decision. See
Brannon’s of Shawnee, Inc. v. Commissioner, 69 T.C. 999, 1002
(1978); see also Kenner v. Commissioner, 387 F.2d 689, 690-691
(7th Cir. 1968); Toscano v. Commissioner, 52 T.C. 295, 296
(1969), vacated on another issue 441 F.2d 930 (9th Cir. 1971);
Campbell v. Commissioner, T.C. Memo. 1988-103. In the cases at
hand, we granted petitioners’ motions for leave in orders filed
in June 2006 (Lius and Lewises) and October 2006 (Hartman),
leaving for further proceedings our determination in this opinion
whether the decisions can and should be vacated.
                               - 14 -

orders of the Court raising questions addressed to the parties,

are undisputed.9

     We believe that all the pending motions may be decided

without a hearing.10   On reflection and reconsideration, we now

decide that the motions to vacate filed by the Lewises should be

granted; we also hold that the motions to vacate filed by Hartman

and the Lius should be granted.   We conclude this opinion by

describing the procedure for implementing our determination that

all Kersting project petitioners against whom stipulated

decisions were entered on or after June 10, 1985, are entitled to

the benefits of the Thompson settlement.   Giving effect to these

decisions and that procedure will result in imposing on

respondent in all Kersting project cases the sanctions mandated

by the Court of Appeals in Dixon V.

                             Background

     When the petitions in these cases were filed, Hartman

resided in Everett, Washington, the Lewises resided in Westlake

Village, California, and the Lius resided in Aiea, Hawaii.




     9
      Decisions in these consolidated cases are appealable to the
Court of Appeals for the Ninth Circuit. Motions similar to those
under consideration herein have been filed and lodged by other
taxpayers whose decisions are appealable to Courts of Appeals for
other circuits.
     10
      Respondent agrees that the Court has before it the records
that produced the Dixon findings and “strenuously opposes” the
scheduling of an evidentiary hearing.
                             - 15 -

I.   The Kersting Project Test Case Proceedings

     In response to the large volume of cases generated by tax

shelter examinations during the late 1970s and early 1980s, the

Internal Revenue Service (IRS) and the Tax Court developed

procedures that were intended to streamline the litigation

process, economize on the use of administrative and judicial

resources, and reduce the costs incurred by taxpayers in

resolving disputes over tax shelter adjustments.   The IRS, Office

of Chief Counsel, in Washington, D.C. (the National Office),

created the Tax Shelter Branch in the National Office to oversee

tax shelter litigation across the country and to organize and

supervise individual tax shelter projects.

     One of the goals of the Tax Shelter Branch was consistent

treatment of similarly situated taxpayers.   The Tax Shelter

Branch monitored settlement offers in similar tax shelter

projects for disparities and tried to determine whether the

project settlement offers should be similar.   However, actual

supervisory responsibility in a tax shelter project was left

primarily in the Regional Counsel’s office and the District

Counsel’s offices to which the project was assigned.

     The deficiencies, additions to tax, and interest at issue in

the Dixon II test case proceedings arose from petitioners’

participation in tax shelter programs promoted by Henry F.K.

Kersting (Kersting) that purported to generate interest
                               - 16 -

deductions for income tax purposes that exceeded amounts paid to

participate in the programs.   Kersting’s promotions of his tax

shelter programs attracted the attention of the IRS, which

instituted a tax shelter project known as the Kersting project.

Kersting actively opposed respondent’s enforcement activities

against his programs.   In early 1982 Attorney Brian J. Seery

(Seery) began assisting Kersting program participants with issues

arising from audits of their income tax returns.   On March 1,

1985, Kersting sent letters informing Kersting program

participants that he had retained Seery to represent them in the

Tax Court at no charge to them.   Ultimately, more than 1,800

cases arising from taxpayers’ petitions against respondent’s

deficiency notices disallowing deductions claimed by participants

in the Kersting programs were filed in the Tax Court.    The bulk

of those deficiency notices were facilitated by respondent’s

having obtained Kersting’s client records in a search of his

office in Honolulu, Hawaii, in January 1981.

     The IRS established the Kersting project in its Honolulu

Appeals Office.   In any given tax shelter project, a project

Appeals officer typically works with a project attorney in the

District Counsel’s office.   In the Kersting project, Kenneth W.

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

the project attorney.
                              - 17 -

     On March 20, 1985, Seery entered his appearance for hundreds

of Kersting project taxpayers.    The Court set for trial the cases

of approximately 375 Kersting program participants to be held

before Judge William A. Goffe (Judge Goffe) at a Tax Court

session scheduled to commence on June 10, 1985, in Honolulu,

Hawaii (the June 1985 session).

     It would have been a daunting task to try the cases of the

hundreds of similarly situated Kersting program participants who

had filed petitions in the Tax Court.    Before the June 1985

session, McWade and Seery agreed to use the test case procedure

whereby a few typical cases are selected and most taxpayers whose

cases are not selected execute “piggyback agreements” binding the

resolution of their cases to the outcome of the final decisions

in the test cases.   During the June 1985 session, McWade and

Seery discussed the use of the test case procedure with Judge

Goffe during a chambers conference.    Consistent with counsels’

agreement to use the test case procedure in the Kersting project,

Judge Goffe granted the parties’ joint motions to continue the

cases called at the June 1985 session.    At the same time, as

early as June 1985, Kersting project petitioners began filing

piggyback agreements, which they did in most of the Kersting

project cases.

     On November 21, 1985, the Chief Judge of this Court assigned

all the Kersting project cases to Judge Goffe for trial or other
                               - 18 -

disposition.    Subsequent Kersting project cases were

automatically assigned to Judge Goffe.

     By letter dated June 10, 1986, McWade notified Judge Goffe

that he and Seery had selected the cases of one individual, Ralph

J. Rina (Rina), and seven couples, including the Thompsons, the

Cravenses, and Jerry and Patricia A. Dixon (the Dixons), to be

test cases.    By letter dated July 30, 1986, Judge Goffe informed

Seery and McWade that the test cases would be set for trial

during a special session of the Court commencing on February 9,

1987, in Wailuku, Maui, Hawaii (the Maui session).    Judge Goffe’s

letter also informed Seery and McWade that he intended to notify

each Kersting project petitioner who had not filed a piggyback

agreement that his or her case would be set for trial during the

Maui session.

     By letter dated August 5, 1986, Judge Goffe informed all

Kersting project petitioners who had not already executed

piggyback agreements that their cases would be set for trial at

the Maui session unless they executed piggyback agreements by

September 29, 1986.    Judge Goffe’s letter stated as follows:

     August 5, 1986

     Dkt #
     Dear _______________:

     Your case involves matters concerning promotions by
     Henry Kersting. Cases with issues identical to the
     issues in your case have been set for trial on February
     9, 1987, at the courtroom of the Circuit Court for the
     Second Circuit in Wailuku, Maui, Hawaii.
                             - 19 -


     In order to conserve the time and expense of the
     taxpayers, the government and the Court, all of the
     cases with identical issues will be tried at one time
     unless the parties agree in advance, in writing, to be
     bound by the outcome of the cases set for trial. In
     most of the pending cases, the parties have so agreed
     to be bound.

     You should contact at your earliest convenience the
     lawyer for the government in the Kersting cases if you
     decide to agree to be bound. He is Mr. Kenneth McWade,
     PJKK Federal Building, Room 3304, Box 50089, 300 Ala
     Moana Boulevard, Honolulu, Hawaii 96850. His telephone
     number is (808) 546-7333. If, however, you do not wish
     to be bound, you should advise my office promptly, in
     writing at the above address, in order that your case
     may be set for trial on February 9, 1987. In either
     event, you must advise Mr. McWade or me by September
     29, 1986.

     If you fail to advise Mr. McWade by September 29, 1986,
     that you wish to be bound and have executed a
     stipulation to be bound by that time and if you fail to
     advise me by September 29, 1986, that you wish to have
     your case set for trial, it will automatically be set
     for trial on February 9, 1987. If your case is set for
     trial and you do not appear for trial, your case will
     likely be dismissed and you will be required to pay all
     of the income tax which the government contends you
     owe, plus interest thereon as provided by law.

     William A. Goffe
     Judge

     In November 1986 the Court issued orders notifying Kersting

project petitioners who had not filed piggyback agreements that

their cases were set for trial at the Maui session.   As

additional Kersting project cases were docketed and identified,

the Court issued orders setting them for trial at the Maui

session, subject to being stricken if the parties executed a

piggyback agreement.
                               - 20 -

     An attorney hired by the Thompsons to prepare an estate plan

for them raised questions with Seery about his association with

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

as counsel for the Thompsons in their docketed cases, which the

Court granted.   In November 1986 the Thompsons engaged Luis

DeCastro (DeCastro) to represent them before this Court.

     In December 1986, following similar questions by the Court,

Seery withdrew as counsel for the other test case petitioners and

all the Kersting project nontest case petitioners for whom he had

filed notices of appearance.   In early January 1987, Kersting

engaged Attorneys Robert J. Chicoine (Chicoine) and Darrell D.

Hallett (Hallett) to represent the test case petitioners (with

the understanding they would not represent Kersting).   Chicoine

and Hallett filed entries of appearance as counsel in each of the

test cases (other than the Thompson and Cravens cases) and

promptly challenged the deficiency notices in the test cases on

the ground that the IRS search of Kersting’s office in January

1981 had been illegal.

     Between 1982 and 1988 respondent had in effect an official

settlement offer for the Kersting project.   In general, the

project settlement offer permitted participants in the Kersting

programs to resolve their cases by agreeing to pay deficiencies

that averaged 7 percent less than those determined in their

deficiency notices.   The project settlement offer also released
                              - 21 -

participants from negligence additions and increased interest.

Respondent’s purpose in offering these concessions and

adjustments was to provide similar treatment for all Kersting

program participants who wished to settle their cases.

     Respondent’s 7-percent reduction project settlement offer in

the Kersting project was similar to the IRS project settlement

offer in other tax shelter projects.   The 7-percent reduction in

the deficiencies reflected allowance of an assumed deduction for

the taxpayers’ out-of-pocket expenses of participating in the

shelter.11

     Although District Counsel generally is expected to adhere to

the terms of an official project settlement offer, once a tax

shelter project is assigned to a particular District Counsel’s

office, that office has the authority to settle any individual

case in the project.   District Counsel has the authority in

special circumstances to settle individual tax shelter project

cases on a basis different from the project settlement offer.

     By September 1986 McWade and Seery had agreed to modify the

7-percent reduction project settlement offer to incorporate a new

feature, called the burnout, that would apply in cases involving


     11
      The 7-percent reduction in the deficiencies amounted to a
“nuisance value” settlement that respondent would not have
entertained or offered in a run-of-the-mill case. See IRM sec.
8.6.1.3.3 (Feb. 18, 1999). Nuisance value is any concession that
is made solely to eliminate the inconvenience or cost of further
negotiations or litigation and is unrelated to the merits of the
issues.
                               - 22 -

more than 1 taxable year.   Under the burnout, the interest on a

taxpayer’s total unpaid Kersting-related deficiencies for the

first and second years of tax liability would not begin to accrue

until the return due date for the second year.    This was

accomplished by zeroing out the taxpayer’s agreed deficiency for

the first year and adding it to the agreed deficiency for the

second year.    The burnout thus postponed for a year the accrual

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

total interest accrued on the taxpayer’s Kersting-related

deficiencies.

     In December 1986 McWade, with the knowledge and connivance

of his supervisor, Honolulu District Counsel William A. Sims

(Sims), entered into secret contingent settlement agreements with

the Cravenses regarding their test cases and with DeCastro

regarding the Thompsons’ test cases.    The Thompsons and the

Cravenses understood that a condition of these settlements was

that they would remain test case petitioners.

     The Cravenses, who were not represented by counsel, agreed

with McWade to a reduction of about 6 percent of the originally

determined deficiencies for their taxable years 1979 and 1980.12


     12
      In the Cravens notices of deficiency, respondent had
determined that the Cravenses were liable for deficiencies for
1979 and 1980 of $4,508 and $19,251.70, respectively, and
additions to tax for negligence under sec. 6653(a) for both
years. The deficiencies and negligence additions so determined
were attributable to the Cravenses’ participation in Kersting tax
shelter programs. The Cravenses’ correct tax liabilities for
                                                   (continued...)
                               - 23 -

This settlement was less favorable to them than the generally

available modified 7-percent reduction settlement offer and did

not include the burnout.

     The initial Thompson settlement in December 1986 reduced the

Thompsons’ total deficiencies by 18.8 percent,13 eliminated the

additions to tax for all years, and eliminated the increased

interest rate under section 6621(d)14 for 1981.   The initial

Thompson settlement also incorporated the burnout, combining the

agreed deficiencies for the years 1979 and 1980 in the year 1980

so as to postpone for 1 year the accrual of interest on the

agreed 1979 deficiency.    On December 23, 1986, McWade sent



     12
      (...continued)
1979 and 1980 were $4,508 and $5,893.45, respectively, for a
total of $10,401.45. The $5,893.45 figure for 1980 represents
the Cravenses’ correct tax liability after eliminating the
dividend adjustment set forth in the notice of deficiency for
1980 and backing out the tax on the capital gain that the
Cravenses had reported on their 1980 tax return. Decisions
entered in the Cravens cases provided that the Cravenses were
liable for deficiencies of $3,606.40 for 1979 and $6,175.76 for
1980, totaling $9,782.16.
     13
      In the Thompson notice of deficiency, respondent had
determined that the Thompsons were liable for deficiencies
totaling $79,293 for the taxable years 1979-81, for additions to
tax for negligence for 1979 and 1981, for increased interest for
1981 pursuant to sec. 6621(d), and for a late filing addition to
tax for 1981 under sec. 6651(a). The deficiencies, negligence
additions, and increased interest were attributable to the
Thompsons’ participation in Kersting tax shelter programs.
     14
      Sec. 6621(d) was redesignated sec. 6621(c) by the Tax
Reform Act of 1986 (TRA), Pub. L. 99-514, sec. 1511(c)(1), 100
Stat. 2744, and repealed by the Omnibus Budget Reconciliation Act
of 1989, Pub. L. 101-239, sec. 7721(b), 103 Stat. 2399. We will
hereinafter refer to the provision as sec. 6621(c).
                               - 24 -

DeCastro decision documents incorporating the above-described

settlement.    McWade’s transmittal letter stated that the decision

documents in the Thompsons’ cases would not be filed with the

Court until the decisions in the test cases had become final.

     Around yearend 1986 the Thompsons paid $59,545 as interest

on their then-agreed deficiencies.      In March 1987 respondent and

DeCastro agreed to a revision of the initial settlement that

effectively increased the reduction in the Thompsons’

deficiencies to approximately 20 percent.     On June 15, 1987, the

Thompsons halted further accrual of interest on the deficiencies

by paying the then total amount owed of $63,000.     By June 1987

payments by the Thompsons to the IRS with respect to the taxable

years 1979-81 (less a $770 offset credited to another year)

totaled $121,770.

     Between September and December 1986 McWade and Sims began to

entertain 20-percent settlements based on the same general

approach as the modified 7-percent settlement offer that included

the burnout.   In late 1986 DeCastro obtained 20-percent reduction

settlements on behalf of other Kersting project nontest case

petitioners he represented, as did Chicoine and Hallett on behalf

of other nontest case petitioners in the course of efforts to

negotiate a global project settlement.

     The enhanced 20-percent settlements reflected the concerns

of McWade and Sims that Chicoine’s and Hallett’s challenge of the
                              - 25 -

IRS search of Kersting’s office increased respondent’s risks of

litigation.   The availability of the 20-percent settlements was

not disseminated in writing by either Sims or McWade.    The

availability of 20-percent settlements became known, if at all,

through a combination of Kersting’s letters to program

participants and telephone inquiries to McWade from Kersting

program participants or their counsel.

     In January 1987 Sims and Chicoine continued their efforts to

negotiate a global settlement of the Kersting project cases.

Initially, they tried to link a higher percentage settlement to

Kersting’s agreement to quit the tax shelter business.     They

eventually abandoned their efforts to link a global settlement to

Kersting’s future conduct.

     By letter dated January 16, 1987, Chicoine notified Kersting

that he believed he had an agreement with Sims to settle all the

Kersting cases docketed in the Tax Court by allowing 50 percent

of the claimed interest deductions.    In that letter, Chicoine

further stated that he and Hallett would agree to represent

Kersting program participants desiring to settle their cases on

these terms for a flat fee of $550 per case.

     On January 19, 1987, Kersting wrote to program participants

that a 50-percent settlement had been negotiated and recommended

that they accept it.   As a result of Kersting’s letter,
                               - 26 -

approximately 300 Kersting program participants contacted

Chicoine and Hallett seeking representation.

     Following the release of Kersting’s January 19, 1987,

letter, Sims received numerous telephone calls from Kersting

program participants and attorneys seeking to accept the

50-percent settlement.    By letter to Chicoine dated February 4,

1987, Sims denied that he had agreed to a 50-percent settlement.

     During spring 1987 Chicoine continued to discuss a global

settlement with McWade.   On or about April 27, 1987, Chicoine

told Kersting he would recommend a 20-percent settlement to

Kersting program participants.    Between May 1987 and February

1988 Kersting wrote at least seven letters to Chicoine and

Hallett strongly objecting to their dissemination of a 20-percent

settlement proposal to Kersting program participants.    On January

12, 1988, Kersting issued a letter encouraging nontest case

Kersting program participants who had paid $550 to Chicoine and

Hallett for representation in the settlement process to “recall

your funds”.

     On February 8, 1988, Kersting wrote to Kersting program

participants warning them that Chicoine and Hallett soon would

circulate the details of a 20-percent settlement.    Kersting urged

Kersting program participants not to hire Chicoine and Hallett to

settle their cases and instead to await the Court’s opinion on

the legality of the search (the issue that had been raised and
                               - 27 -

presented by Chicoine and Hallett).     During this period, Kersting

threatened to sue Chicoine and Hallett if they reported the 20-

percent settlement offer to the Kersting program participants.

     On February 9, 1988, Chicoine sent letters to Kersting

program participants who had contacted Chicoine and Hallett

about representation.   Chicoine reported that McWade had offered

to settle docketed Tax Court cases in accordance with the

20-percent settlement offer, recommended that program

participants seriously consider that settlement, and suggested

that those who desired to settle on those terms contact Chicoine

and Hallett.

     On February 11, 1988, the Court filed Dixon v. Commissioner,

90 T.C. 237 (1988) (Dixon I), holding that the test case

petitioners had failed to establish standing to contest the IRS

search of Kersting’s office.

     Kersting was displeased by Chicoine’s and Hallett’s

proposed overall disposition of the Kersting project cases with

only a 20-percent reduction in the deficiencies.    He fired

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

(Izen), to represent the test case petitioners at trial.

     In April 1988 Chicoine and Hallett informed their test case

petitioner clients that they were withdrawing as their counsel

because of a disagreement with Kersting.    Chicoine and Hallett,

however, continued to negotiate settlements for nontest case
                              - 28 -

petitioners, including Hartman.   By letter dated June 9, 1988,

Chicoine and Hallett informed McWade that Hartman wished to

accept the 20-percent settlement with the burnout.   McWade sent

Chicoine stipulated decisions for Hartman’s cases.   Chicoine

executed the decision documents on Hartman’s behalf and returned

them to McWade on November 30, 1988.   McWade executed the

decisions on December 12, 1988.   On January 13, 1989, the Court

entered the stipulated decisions in Hartman’s cases at docket

Nos. 1371-85, 4116-87, and 16761-87.

     In the meantime, DeCastro told McWade the Thompsons were

concerned about the legal fees they would incur as test case

petitioners.   DeCastro told McWade that it was unfair to require

the Thompsons to remain test case petitioners and that he would

attempt to remove the Thompsons’ cases from the list of test

cases.   McWade wanted to keep the Thompsons as test case

petitioners.   DeCastro and McWade resolved their differences by

further modifying the Thompson settlement.   In particular, McWade

agreed to reduce the Thompsons’ deficiencies by an additional

amount that would compensate them for the cost of having an

attorney represent them at the trial of the test cases.

     Shortly before trial of the test cases in this Court, McWade

and DeCastro reached an oral agreement (the final Thompson

agreement) in the Thompsons’ cases calling for reduction of the

agreed deficiencies for 1979, 1980, and 1981 to zero, $15,000,
                                    - 29 -

and $15,000, respectively.        The purpose of the final Thompson

agreement was to generate a refund, estimated to exceed $60,000,

that was to be used--and the bulk of which was used--to pay

DeCastro’s fees for providing the appearance of independent

representation of the Thompsons at the trial of the test cases.

Although McWade knew that IRS policy required him to treat

similarly situated taxpayers alike, the financial terms of

McWade’s final settlement with DeCastro for the Thompsons were

much more advantageous to them than McWade’s settlements with

other Kersting project petitioners.15

     After the trial of the test cases, John R. Thompson

(Thompson) expressed concern to DeCastro about incurring

DeCastro’s additional fees.        DeCastro assured Thompson that

DeCastro was looking solely to the IRS for payment of his fees

and that the Thompsons would not be liable for any additional

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

reducing the final Thompson agreement to writing.        McWade signed

the letter and returned it to DeCastro.

     Sims, McWade, and DeCastro did not inform the Court, the

National Office, the Regional Office, or counsel for the other

test case petitioners or any of the other Kersting project

petitioners or their counsel of the Thompson settlement or the


        15
      With the exception of Denis Alexander, a nontest case
petitioner with whom McWade made a special deal. See infra p.
30.
                               - 30 -

Cravens settlement.    McWade’s deception continued with a coverup,

which was carefully designed to prevent the Court and other

Kersting participants from learning of the secret settlement

agreements.    At Kersting’s deposition, which McWade attended,

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

attorney because of rumors that the Thompsons were attempting to

settle.    Although McWade knew that the Thompsons had, in fact,

already settled, he remained silent.    McWade then misled the

Court by failing to disclose the settlement on April 22, 1988,

when he moved to set aside the Thompson piggyback agreements, a

necessary pretrial motion that confirmed the inclusion of the

Thompson cases among the test cases.

     Before the trial of the test cases, McWade arrived at a

general understanding with nontest case petitioner Denis

Alexander (Alexander) that the Alexanders’ tax liabilities for

the taxable years 1974-77 would be reduced in exchange for

Alexander’s testimony and agreement to serve as an undisclosed

consultant or assistant to McWade during the trial of the test

cases.    McWade’s understanding with Alexander is reflected in

decision documents, executed by McWade on April 6, 1989, and

approved by Sims, that completely eliminated all Kersting and

other deficiencies determined against the Alexanders for those

years.
                               - 31 -

     On January 10, 1989, the test cases were consolidated for

trial and opinion.    The trial of the test cases was conducted

from January 9 to 27, 1989, at Honolulu, Hawaii, with DeCastro

representing the Thompsons and Izen representing all the other

test case petitioners except the Cravenses, who were pro sese.

McWade’s deceptive silence matured into overt misconduct during

the trial of the test cases; when Thompson began to testify about

having settled his cases, McWade quickly interjected questions

about unrelated matters.    The diversion was successful; the Court

mistakenly interpreted Thompson’s remark as referring to

resolution of the Thompsons’ tax liability for another year that

was not at issue.    McWade also allowed Alexander to offer

misleading testimony that prevented the Court from learning that

McWade had agreed to zero out the Alexanders’ tax liabilities.

     On December 11, 1991, the Court issued its opinion in Dixon

II, sustaining almost all of respondent’s determinations that the

Kersting programs in issue were ineffective for tax purposes.

     In March 1992 the Court entered decisions in all the test

cases in accordance with its opinion in favor of respondent.

Consequently, the decisions initially entered in the Thompson and

Cravens cases were not in accordance with their secret settlement

agreements.   Izen appealed the decisions against the test case
                              - 32 -

petitioners (with the exception of the Thompsons, the Cravenses,

and Rina) to the Court of Appeals for the Ninth Circuit.

II.   Respondent’s Discovery and Disclosure of the Thompson and
      Cravens Settlements

      On May 8, 1992, after this Court had entered decisions in

favor of respondent in all the test cases, McWade and Sims, by

memorandum, requested the San Francisco Appeals Office to process

the Thompsons’ account administratively in accordance with the

Thompson settlement, not the Tax Court’s decisions.    On May 22,

1992, Danny Cantalupo, Regional Director of Appeals for the

Western Region, informed Peter D. Bakutes (Bakutes), Deputy

Regional Counsel for Tax Litigation for the Western Region in San

Francisco, of McWade’s and Sims’s request to process the Thompson

settlement.   Bakutes informed Benjamin Sanchez (Sanchez), Western

Regional Counsel in San Francisco, who informed officials in the

National Office.   The circumstances of the Thompson settlement

caused widespread concern within the IRS.

      On May 29, 1992, Sims, at the direction of Sanchez, informed

DeCastro by letter that the Thompson settlement would not be

honored, and that assessments would be made in accordance with

the decisions entered on March 13, 1992, pursuant to Dixon II.

The letter advised that assessment of the taxes owing, plus

statutory additions and interest, would be “approximately

$302,396.12”.   The letter further noted:   “Of course, your
                                - 33 -

clients’ advance payments will be credited toward the

assessments.”

     DeCastro had several telephone conversations with

respondent’s officials, in which he maintained that the Thompson

settlement, as memorialized in the August 3, 1989, letter

agreement, was an enforceable contract, and that he would appeal

any decision to the contrary.

     Soon after Sanchez and Bakutes discovered the Thompson

settlement, McWade and Sims disclosed the Cravens settlement to

them.   Sanchez promptly notified David Jordan (Jordan), Acting

Chief Counsel, about the Thompson settlement.   Sanchez and Jordan

agreed that the Tax Court had to be notified immediately.

     Bakutes prepared a motion that was filed in this Court on

June 9, 1992, seeking leave to vacate the decisions entered in

the Thompson, Cravens, and Rina test cases, which had not become

final and had not been appealed.    Unlike the Thompsons and the

Cravenses, Rina had not entered into a settlement agreement with

McWade and Sims, and the decision that had been entered in his

case was in accordance with Dixon II.    In the motion, respondent

acknowledged that the existence of the secret agreements and “the

failure to divulge same to the Court and the other Test Case

petitioners prior to the trial raises questions which should be

addressed by the Court and the parties after a full hearing

before the Court.”   Respondent requested the Court to conduct an
                              - 34 -

evidentiary hearing to determine whether the agreements with the

Cravenses and the Thompsons had affected the trial of the test

cases or the ensuing decisions of the Court.

     On or about June 11, 1992, Sanchez decided that McWade and

Sims should no longer have any authority over the Kersting

project and that all Kersting project cases should be assigned to

other attorneys who were familiar with the Kersting project.

Bakutes accordingly reassigned the 14 test case dockets to Thomas

A. Dombrowski (Dombrowski) and the nontest cases to Henry E.

O’Neill (O’Neill).

     On June 22, 1992, the Court granted respondent’s motions to

vacate in the Thompson and the Cravens cases.   The Court ordered

the parties within 30 days to file agreed decisions or otherwise

move as appropriate.   The Court denied respondent’s request for

an evidentiary hearing.   In a separate order entered on the same

date, the Court denied respondent’s motion to vacate the decision

in the Rina test case, stating:

     The Court has reviewed the testimony of Cravens, the
     testimony of Thompson, the stipulated facts and
     stipulated exhibits relating to the Cravenses and the
     Thompsons, and the exhibits offered through Thompson as
     a witness. The Court finds that these reviewed items
     had no material effect on the opinion which the Court
     filed on December 11, 1991, as that opinion relates to
     petitioner Rina. If the reviewed items were stricken
     from the record, the Court would file an opinion in all
     material respects like the opinion it filed on December
     11, 1991 (with the exception of certain portions
     relating specifically and expressly to the Cravenses or
     the Thompsons), and the Court’s findings, analyses, and
                               - 35 -

     conclusions relating to petitioner Rina would remain
     the same. * * *

     The Court’s order denying respondent’s motion to vacate the

decision in the Rina case was consistent with this Court’s

holding in Chao v. Commissioner, 92 T.C. 1141 (1989), that the

Court will not vacate a decision if a new trial would not result

in a different decision.    Rina appealed his decision to the Court

of Appeals for the Ninth Circuit, where appeals in the other

Kersting project test cases were pending.

     The same day the Court acted on respondent’s motions to

vacate, Bakutes telephoned DeCastro to tell him that the

decisions in the Thompson cases had been vacated.    During the

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

Thompsons’ deficiencies to keep the Thompsons in the test case

trial.    Although DeCastro had earlier told Bakutes that

attorney’s fees had not figured in the settlement, he admitted in

this conversation that the deficiencies had been reduced to pay

the Thompsons’ legal fees for his representation of them in the

test case trial.

     During the summer of 1992, Jordan directed two senior

attorneys in the Tax Litigation Division in the National Office,

Thomas J. Kane (Kane) and Steven M. Miller (Miller), to

investigate the Thompson settlement on behalf of the National

Office.    Kane and Miller conducted in-house depositions and
                                - 36 -

interviewed various individuals who had participated in the test

case trial and the Thompson settlement.

     Bakutes assigned Dombrowski to help Kane and Miller in their

investigation.   Dombrowski’s immediate problem was how to respond

to this Court’s order of June 22, 1992, that within 30 days the

parties file agreed decisions or otherwise move.

     On June 24, 1992, Marlene Gross (Gross), an official in the

National Office, called Bakutes and informed him that the

Department of Justice (DOJ) would not seek remand of the test

cases that had been appealed.    The DOJ’s decision was based on

the Tax Court’s refusal to vacate the decision in the Rina case.

That refusal indicated to the DOJ officials that the Tax Court

would probably reject any request by respondent to vacate the

Court’s decisions in the other test cases.   Gross also reported

to Bakutes that the DOJ, specifically the Tax Division’s

Appellate Section Chief Gary Allen, wished to offer the same

settlement to the test case petitioners on appeal that the

Thompsons had received:   a 65-percent reduction in deficiencies

(a rough approximation of the reduction of the Thompsons’

originally determined deficiencies from $79,293.52 to the $30,000

figure finally agreed upon).    Bakutes was opposed to settling the

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

basis was made to the test case petitioners on appeal.
                              - 37 -

     In July 1992 DeCastro filed a motion for entry of decision

in the Thompson cases in accordance with the final agreement he

had reached with McWade shortly before trial; i.e., deficiencies

of zero, $15,000, and $15,000 for 1979-81, respectively.    On

August 20, 1992, respondent filed objections to DeCastro’s motion

for entry of decision, together with respondent’s own motions for

entry of decision and an accompanying memorandum.   Respondent’s

motion acknowledged that the Thompsons were entitled to the

original 18.8-percent reduction settlement agreed to by McWade

and DeCastro in December 1986 and sought decisions to that

effect; respondent argued that the “New Agreement”, intended to

pay the Thompsons’ legal fees, was unauthorized and had no legal

basis.

     Respondent’s 11-page motion for entry of decision, with a

15-page supporting memorandum, set forth the facts regarding the

Thompson settlement that had been discovered by IRS senior

officials.   Respondent informed the Court that before the test

case trial McWade and Sims had agreed to sweeten the prior

settlements of the Thompson cases by further reducing the

Thompsons’ deficiencies in order to compensate them for their

projected attorney’s fees.   As respondent explained to the Court,

McWade and Sims had agreed with DeCastro that

     All settlement refunds in excess of the amounts
     provided by the December 1986 agreement would go
     ultimately to the benefit of Mr. DeCastro for payment
     of his legal fees and costs. Mr. DeCastro would be
                             - 38 -

     paid solely from amounts refunded by the Service to
     Thompson. * * * This “New Agreement”, in sum and
     substance, if not explicitly, was designed, and
     constituted an agreement by Messrs. Sims and McWade to
     pay Mr. DeCastro’s legal fees and expenses.

     Respondent’s motion papers compared the amounts of the

Thompsons’ deficiencies originally determined for the 3 years at

issue, totaling $79,293.52, with the unauthorized “New Agreement”

reducing the deficiencies to zero, $15,000, and $15,000, or

total deficiencies of only $30,000, thus generating the refunds

used to pay DeCastro’s legal fees.    These figures, without more,

indicate that the “New Agreement” represented a 62-percent

reduction of the deficiencies respondent originally determined.

     In respondent’s memorandum of points and authorities in

support of respondent’s motion for entry of decision, respondent

acknowledged that “counsel for both parties owed a special

obligation of candid disclosure to this court given the highly

unusual circumstances which were of their own making.”

Respondent acknowledged that the Rules of this Court and the

Model Rules of Professional Conduct require the utmost candor to

the Court, “which duty would proscribe misleading the court by

silence, inaction, or failure to apprise the court of any

material fact that may affect the proceeding before the court.”

Respondent further acknowledged:

     as officers of the court, both the District Counsel
     attorneys and petitioners’ counsel owed a special duty
     to disclose to this court that they had entered into an
     agreement to settle the litigation and that District
                             - 39 -

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

     On August 26, 1992, the Court entered orders and decisions

in the Thompson cases summarily denying respondent’s motion for

entry of decision, granting DeCastro’s motions for entry of

decision, and entering decisions in accordance with the final

Thompson agreement.

     Respondent did not appeal the decisions the Court entered in

the Thompson and the Cravens cases.    As a result, those decisions

became final, while Rina and the other test case petitioners, who

had appealed the decisions entered in their cases, added the

newly revealed facts about the misconduct of respondent’s

attorneys to the grounds for their appeals.

     The rationale of the Office of Chief Counsel for not

appealing the Tax Court’s entry of the decisions giving effect to

the Thompson settlement was set forth in a memorandum, dated

September 8, 1992, prepared by Kane:
                              - 40 -

     The Chief Counsel [Abraham N.M. Shashy, Jr.] and Deputy
     Chief Counsel have concluded that, under the
     circumstances, we have completely fulfilled all
     applicable ethical and legal obligations with respect
     to this issue and this litigation. They have also
     concluded that given the fact that the conduct on the
     part of our attorneys is significantly less than
     exemplary, there is nothing to be gained by further
     prolonging this aspect of the Kersting litigation.

     On September 30, 1992, Judge Goffe terminated his recall

status as a Senior Judge and retired from the bench.   The Chief

Judge of the Tax Court reassigned the Kersting project cases to

Judge Renato Beghe.

     In October 1992 Izen and Robert Patrick Sticht (Sticht),

representing various nontest case petitioners, filed separate

motions with the Tax Court to intervene in the Thompson and

Cravens cases, before the newly entered decisions in those cases

had become final.   Sticht and Izen maintained that their clients

should be allowed to intervene in those cases in order to assert

that McWade had committed fraud on the Court by arranging the

Thompson settlement and failing to inform the Court or the other

parties.

     On November 6, 1992, we denied the motions to intervene.

Izen and Sticht filed notices of appeal of our denials of their

intervention motions, again alleging fraud on the Court.
                              - 41 -

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

     After the Court filed Dixon II, Kersting kept the

participants in his programs informed about the status of the

test cases.   In February 1992, Kersting sent a lengthy “Dear

Friend” letter to the participants in his programs, informing

them that Izen was preparing an appeal of Dixon II in the test

cases to be filed with the Court of Appeals for the Ninth

Circuit.   Kersting’s letter also said he had formed a defense

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

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

President”.

     Subsequently, Attorneys Robert Alan Jones (Jones) and Declan

J. O’Donnell (O’Donnell) announced the Henry Kersting Tax Defense

Group.   A defense group brochure created in May 1992 describes the

legal services O’Donnell and Jones would offer to Kersting program

participants.   The brochure included a description of the

qualifications and practice backgrounds of O’Donnell and Jones,

along with retainer agreements and copies of relevant memoranda

and correspondence.   One such memorandum, entitled “Status of the

Kersting Cases”, signed by O’Donnell and dated May 12, 1992, said

that most of the Kersting program participants had executed

piggyback agreements to be bound by the results in the test cases

and that the test cases had been decided for the Government.     It
                               - 42 -

said that the deadline for filing an appeal was June 11, 1992, and

that Izen was representing the test case petitioners and would

handle the appeal.

     After the Court had denied respondent’s motions to vacate the

Rina decision and for an evidentiary hearing and had vacated the

original Thompson and Cravens decisions, Jones and O’Donnell wrote

Dombrowski a joint letter dated June 24, 1992.    They informed

Dombrowski that they represented approximately 100 Kersting

project taxpayers and that they understood Dombrowski had replaced

McWade as respondent’s counsel because of an ethical concern

regarding the impropriety of the secret settlements with the

Cravenses and the Thompsons.

     The letter acknowledged that the Court had concluded that the

newly disclosed “Contingent Settlements” would not change its

opinion in any material way and had denied a motion to vacate

decision filed in a case that was not on appeal.    The letter also

stated that motions to remand were pending before the Court of

Appeals for the Ninth Circuit in cases that had been appealed.

     By letters dated June 24 and August 12, 1992, Jones and

O’Donnell asked Dombrowski to provide informal discovery regarding

the Thompson and Cravens settlements.   Respondent refused their

informal discovery requests and did not allow them to participate

in any of respondent’s in-house investigations.
                                 - 43 -

     In a letter dated July 31, 1992, Kersting informed the

Kersting program participants that Izen and Sticht were “exposing

the government’s fraud and perfidy in a secret deal between

Cravens and Thompson on the one hand, and IRS attorney McWade (and

other government officials) on the other hand.”    Kersting

explained his version of the misconduct of the Government’s

attorneys as follows:   “As many of you already know, the growing

scandal in the ‘piggyback’ cases involves a settlement in favor of

Cravens/Thompson in exchange for their damaging testimony and

exhibits that were all put together as part of a prearranged plan

to influence and persuade Judge Goffe to rule against us.”

     On September 14, 1992, Kersting wrote another “Dear Friend”

letter informing the Kersting participants of further

developments.   Kersting said the misconduct of Sims, McWade, and

DeCastro “threw the appeals schedule into turmoil and motions had

to be filed to ask for an extension of time for filing the

Appeal.”   Kersting advised them to ask for “the same concessions

arranged by the Revenue Service to Thompson and Cravens.      An

arrangement whereby $100,000.00 of taxes allegedly owed were

reduced to a mere $15,000.00.”    This “Dear Friend” letter

concluded by disclosing that relations had soured between Kersting

and the “Henry Kersting Tax Defense Group” of O’Donnell and Jones.
                                - 44 -

IV.   Respondent’s Posttrial Settlement Offer

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

discussions about offering a 7-percent reduction settlement to

Kersting project petitioners who were bound by the test cases

through piggyback agreements.

      On September 9, 1992, Dombrowski sent a draft of a proposed

settlement offer letter (Dombrowski draft) to Paul Zamolo, Acting

Deputy Regional Counsel.   The Dombrowski draft explained that the

Tax Court had issued its Dixon II opinion disallowing the interest

deductions, imposing additions to tax for negligence under section

6653 and substantial understatement of tax under section 6661, and

finding that the increased interest rate under section 6621(c)

applied.   The Dombrowski draft stated that five of the test case

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

appealing their cases in the Ninth Circuit, but that the appeals

had not yet been resolved.   The Dombrowski draft further stated

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

Rina, and Thompson test cases because “it appeared that a

settlement agreement had been reached with two [sic] of the test

case petitioners, the Cravens [sic] and the Thompsons, prior to

the trial of the test cases.”   The Dombrowski draft then described

the action taken by the Court as follows:

           The Tax Court granted the Motions to   Vacate
      Decision which were filed in the Thompson   and Cravens
      cases. The Court directed the parties to    either file
      agreed decisions or motions regarding the   decisions to
                               - 45 -

     be entered in the cases. Agreed decisions were filed in
     the Cravens’ cases reflecting the Cravens’ pre-trial
     acceptance of the standard Kersting settlement offer.
     The parties were unable to agree on the decisions to be
     filed in the Thompson cases. Thereafter, motions for
     entry of decision were filed by both the government and
     the Thompsons. The Tax Court granted the Thompsons’
     motions and entered decisions accordingly.

          The Court denied the Motion to Vacate Decision
     filed in the third case involving petitioner Ralph J.
     Rina. In denying the Motion to Vacate Decision the
     Court stated that the testimony and evidence offered by
     Mr. Thompson and Mr. Cravens had no material effect on
     the opinion as it related to Mr. Rina and therefore the
     Court’s findings, analyses and conclusions relating to
     him would remain the same. Accordingly, all Kersting
     interest deductions were disallowed and all additions to
     tax were sustained as to Mr. Rina. * * *

          * * * It is the Service’s belief that the trial
     Court’s disallowance of interest deductions and the
     imposition of the additions to tax will be upheld on
     appeal.

     The Dombrowski draft then stated that the IRS had decided to

renew its previous offer of the 7-percent settlement including the

burnout and enclosed a form on which the taxpayer could indicate

his/her acceptance of the offer.   The Dombrowski draft stated:

“the offer applies only to adjustments resulting from your

participation in the various Kersting programs referred to above.

Any other adjustments raised in your case will be considered on an

item by item basis and will be settled or litigated as

appropriate.”

     A September 30, 1992, shorter draft of a settlement proposal

prepared by Sanchez (Sanchez draft) gave much less detail than the

Dombrowski draft.   The Sanchez draft referred to the Tax Court’s
                                   - 46 -

decision but did not name the case or cite Dixon II.      It only

identified Cravens as one of two test cases in which “some

irregular and undisclosed agreements” had been reached.      The

Sanchez draft stated that the Tax Court had concluded that the

outcome of the trial was unaffected by the irregular activity and

that decisions had been entered in the two test cases enforcing

the undisclosed agreements.       The Sanchez draft did not identify

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

were being appealed.       The Sanchez draft stated:

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

                *      *      *    *    *    *    *

          We have determined that the Cravens [sic] in good
     faith believed that they had a valid settlement
     agreement prior to the trial. Because they were not
     represented by counsel, they could not be expected to
     have detected any irregularity on our part.

          Because the Cravens [sic] received the benefit of
     this offer even after trial, we believe that fundamental
     fairness compels that you should receive the same
     treatment. Therefore, we will apply the benefits of
     that treatment to your case.

     The Sanchez draft stated that the adjustments to the

taxpayer’s account with the IRS would be made administratively and

required no further action by the taxpayer.

     A third draft dated October 26, 1992, prepared by Kane (Kane

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

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

test cases.   The Kane draft stated that two of the test case
                                 - 47 -

petitioners had entered into settlement agreements that had not

been disclosed to the other test case petitioners or the Tax Court

but did not identify the taxpayers who had entered into the

undisclosed settlement agreements.    The Kane draft stated that the

Tax Court had concluded that the outcome of the trial was

unaffected by the testimony of the test case petitioners who had

settled their cases.   The Kane draft stated:   “This means that the

opinion of the Tax Court, as it affects you, remains unchanged.”

The Kane draft did not disclose that the Dixons and some of the

other test case petitioners had filed appeals with the Court of

Appeals for the Ninth Circuit.

     The Kane draft stated that “fundamental fairness dictates

that you be afforded an opportunity to settle your case on similar

grounds”.   The Kane draft, like the Sanchez draft, indicated that,

if the taxpayer’s case had been settled, the adjustments would be

made administratively without requiring further action from the

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

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

that acceptance of the offer would “preclude any further

challenges or appeal with respect to the merits of the Dixon

opinion as applied to your case(s).”

     On January 8 and 29, 1993, respondent made mass mailings

extending a global settlement proposal to all known Kersting

project nontest case petitioners and their counsel (posttrial
                                - 48 -

settlement offer).   The posttrial settlement offer informed

petitioners that the Court had issued its opinion sustaining all

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

trial of the test cases:

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

     In general, the posttrial settlement offer represented a

revival of the official project settlement that respondent had

offered during 1982-88.    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 would

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

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

settlement offer did not include the burnout.

     The posttrial settlement offer further stated:     “Acceptance

of this settlement offer will preclude any further challenge or
                                 - 49 -

appeal with respect to the Kersting programs or the merits of the

Dixon opinion.   Any other issues involved in this case will be

resolved separately.”   Taxpayers were given 60 days within which

to accept or reject the posttrial settlement offer.

V.    The Lewis and Liu Settlements

      In a letter dated March 11, 1993, O’Donnell informed

respondent’s counsel that the Lewises had decided to accept the

posttrial settlement offer.16    Thereafter, respondent forwarded a

stipulated decision document to O’Donnell and Jones reflecting a

disposition of the Lewises’ cases on the terms set forth in the

posttrial settlement offer.     On May 17, 1993, O’Donnell signed the

decision documents in docket Nos. 15673-87 and 18551-88; on May

18, 1993, Jones signed the decision document in docket No. 29429-

88.   On June 16, 1993, O’Neill signed the Lewises’ decision

documents on behalf of respondent.    On June 23, 1993, the Court

entered the decisions in the Lewises’ three dockets.    On September

22, 1993, the decisions became final under section 7481.

      The Lius, proceeding pro sese,17 also accepted the posttrial

settlement offer.   On March 10, 1993, the Court entered the



      16
      O’Donnell and Jones had entered their appearances on
behalf of the Lewises in the present cases on July 6, 1992.
      17
      The Lius were represented by Thomas P. Dunn from May 26,
1987, to July 21, 1989. Their present counsel, Matthew K. Chung,
entered his appearance in these proceedings on Oct. 18, 2004,
when he filed the Lius’ motion for leave to file motion to vacate
their stipulated decision.
                               - 50 -

stipulated decision in the Lius’ case, docket No. 48690-86.       On

June 8, 1993, the decision became final under section 7481.

      When respondent submitted the stipulated decision documents

obtained through the posttrial settlement offer to the Tax Court

and asked the Court to enter those stipulated decisions,

respondent did not file a copy of the posttrial settlement offer

with the Court.

VI.   Disciplinary Actions Against McWade and Sims

      On July 29, 1993, respondent’s management sent notices of

proposed disciplinary action to McWade and Sims.     The notices

asserted that McWade and Sims had violated:   (1) Department of the

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

employee shall avoid any action which might result in or create

the appearance of giving preferential treatment to any person);

(2) Department of the Treasury Minimum Standards of Conduct,

section 0.735-30(a)(6) (an employee shall avoid any action that

might adversely affect the confidence of the public in the

integrity of the Government); and (3) IRS Rule of Conduct 214.5

(an employee will not intentionally make false or misleading oral

or written statements in matters of official interest).     The

notices proposed to suspend both McWade and Sims for 14 calendar

days without pay.

      The Notices of Proposed Disciplinary Action to McWade and

Sims listed the following reasons for the proposed disciplinary
                               - 51 -

actions:   (1) Negotiating an unauthorized settlement agreement

with the Thompsons; (2) basing the Thompson settlement on

unaudited and insufficiently documented losses from an unrelated

shelter; (3) allowing the Thompsons a settlement that provided

them more favorable treatment than other taxpayers;

(4) compensating the Thompsons for their attorney’s fees; and

(5) not informing the Tax Court of the Thompson settlement

arrangements.

     McWade and Sims were both suspended for 2 weeks without pay

and transferred from the Honolulu Division.   Sims accepted these

disciplinary actions and was transferred to the San Francisco

Regional Counsel’s Office, where he was assigned nonsupervisory

duties as a Special Litigation Assistant in the General

Litigation area.   Rather than accept a transfer to the Los

Angeles District Counsel’s office, McWade retired from the IRS,

effective October 2, 1993.

     On April 1, 1999, the day immediately following the issuance

of the Dixon III opinion, we referred the misconduct of Sims,

McWade, and DeCastro to the Committee on Admissions, Ethics, and

Discipline of the Tax Court.   On April 22, 2003, following the

issuance of the Court of Appeals opinion in Dixon V and entry of

its primary mandate, the Tax Court, through the Committee on

Admissions, Ethics, and Discipline, issued orders to Sims,

McWade, and DeCastro to show cause why they should not be
                                - 52 -

suspended or disbarred from practice before the Court or

otherwise further disciplined.     On July 1, 2003, DeCastro

resigned from practice before the Court.

     The Tax Court, acting on the orders to show cause and the

recommendations of the Committee on Admissions, Ethics, and

Discipline, suspended McWade and Sims from practice before the

Court for 2 years, commencing February 20, 2004.     The Arkansas

State Bar suspended Sims’s license to practice law for 1 year in

February 2004, and the Oregon State Bar suspended McWade’s

license to practice for 2 years in August 2004.     The Director of

the IRS Office of Professional Responsibility suspended McWade

and Sims indefinitely from practice before the IRS, effective

June 9, 2004.18

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

     Respondent did not appeal the decisions this Court entered

in the Thompson and the Cravens cases in accordance with the

secret settlement agreements.19    As a result, those cases were

closed.     The remaining test case petitioners, including Rina,

appealed the decisions entered in their cases to the Court of



     18
      Following what Attorney Michael Louis Minns interpreted as
a suggestion or order by a member of the panel that heard oral
argument on the appeal that resulted in Dixon V, Minns filed the
complaints that resulted in the disciplinary actions by the
Arkansas and Oregon Bars and the IRS Office of Professional
Responsibility.
     19
          See the Kane memorandum dated Sept. 8, 1992, supra p. 40.
                              - 53 -

Appeals for the Ninth Circuit; they included facts about the

misconduct of respondent’s attorneys as grounds for their

appeals, which they characterized as fraud on the court.

Additionally, Izen and Sticht separately appealed to the Court of

Appeals for the Ninth Circuit our orders denying their motions to

intervene in the Thompson and Cravens cases on behalf of various

Kersting project nontest case petitioners.20

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

     In DuFresne v. Commissioner, 26 F.3d 105 (9th Cir. 1994),

the Court of Appeals for the Ninth Circuit vacated the decisions

entered against the test case petitioners (other than the

Thompsons and Cravenses) on the ground that the misconduct of

McWade and Sims required further inquiry.

     The Court of Appeals noted that in respondent’s motions to

vacate decision filed in the Tax Court respondent had “presented

a telling case of corruption of the process of the tax court and

the rights of both the government and the taxpayers” and that the

parties wrongly believed that the test cases were fairly

representative of all the other cases and were not sham or

collusive proceedings.   The Court of Appeals found that the

taxpayers, the Government, and the Tax Court had all been cheated


     20
      Izen and Sticht also filed appeals of our orders denying
their motions to intervene in the Thompson and Cravens cases in
the Courts of Appeals for the Second and Tenth Circuits. Those
appeals were dismissed for procedural reasons and not on the
merits.
                               - 54 -

by the conduct described in the appeal; i.e., that a secret

settlement agreement entered into between respondent and the

Thompsons was contingent upon the Thompsons’ not prevailing in

their cases, and that, in effect, the Government agreed to pay

the Thompsons’ legal fees, and that the Cravenses had entered

into a similar agreement.   The Court of Appeals also noted that

Rina had alleged, in a motion for reconsideration in the Tax

Court, that the Thompsons’ attorney (who was the main beneficiary

of the settlement) was privy, at his insistence, to the test case

trial strategy, read counsel’s trial notes, and overheard

communications with clients.

     The Court of Appeals stated that it could not determine from

the appellate record “whether the extent of misconduct rises to

the level of a structural defect voiding the judgment as

fundamentally unfair, or whether, despite the government’s

misconduct, the judgment can be upheld as harmless error.     See

Arizona v. Fulminante, 499 U.S. 279, 309 (1991).”   Id. at 107.

     The Court of Appeals vacated the decisions entered in the

remaining test cases and remanded the cases to this Court with

directions to hold an evidentiary hearing to determine the full

extent of the misconduct of McWade and Sims.   The Court of

Appeals also directed the Tax Court to consider on the merits all

motions of intervention filed by affected parties and stated that

all subsequent appeals would be scheduled before the same panel.
                             - 55 -

     In Adair v. Commissioner, 26 F.3d 129 (9th Cir. 1994), an

unpublished opinion filed the same day as the DuFresne opinion,

the DuFresne panel also dismissed the Kersting project nontest

case petitioners’ appeals of our orders denying their motions to

intervene in the Thompson and Cravens cases.    Notwithstanding (1)

the Kersting project nontest case petitioners’ allegations that

the misconduct of the Government attorneys was a fraud on the Tax

Court, (2) the DuFresne panel’s conclusions in DuFresne that the

process of the Tax Court had been corrupted and that the test

case trial was a sham or collusive proceeding, and (3) the

holding in Toscano v. Commissioner, 441 F.2d 930, 934 (9th Cir.

1971), vacating 52 T.C. 295 (1969), that the Tax Court has

jurisdiction to set aside a final decision where a fraud has been

perpetrated on the Court, the DuFresne panel held that the

decisions entered in the Cravens and Thompson cases were final

and that the Tax Court lacked jurisdiction to vacate them, citing

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

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

     In May-June 1996 we conducted the evidentiary hearing

directed by the Court of Appeals in DuFresne.    To give effect to

the directive of the Court of Appeals that the Tax Court consider

on the merits all motions of intervention filed by affected

parties, we ordered the consolidation of 10 nontest cases, each
                                - 56 -

represented by Izen, Sticht, or Jones, with the remaining test

cases for purposes of the evidentiary hearing.21

      Shortly before the evidentiary hearing, held in May-June

1996, the parties discovered that decisions entered in the

Alexander cases zeroed out the Alexanders’ deficiencies for 1974-

77.

      In Dixon III, filed March 30, 1999, we made detailed

findings of fact concerning McWade’s and Sims’s misconduct during

the Kersting test case proceedings.      Our ultimate findings

included the following.

      (1) McWade and Sims negotiated a series of contingent

settlement agreements with DeCastro in respect of the Thompsons’

tax liabilities in advance of the trial of the test cases.       The

final Thompson settlement agreement provided for a reduction in

the Thompsons’ tax liabilities for the purpose of generating

refunds to pay DeCastro’s attorney’s fees.

      (2) McWade and Sims negotiated a contingent settlement

agreement with John R. Cravens (Cravens) in respect of the

Cravenses’ tax liabilities in advance of the trial of the test

cases.     McWade and Sims misled Cravens about the nature and legal



      21
      The Gridleys and the Fleers, Kersting project nontest case
petitioners who were represented by O’Donnell, were originally
included in the consolidation for the evidentiary hearing.
However, before the hearing, we severed their cases from the
consolidation, at O’Donnell’s request, so they could
independently pursue their summary judgment motions described
infra Part VII.C.
                              - 57 -

effect of his settlement and his need for counsel at the trial of

the test cases.   In so doing, they foreclosed the possibility

that the Cravenses would obtain counsel, thereby reducing the

effectiveness of Cravens’s testimony and presentations to the

Court from the point of view of all test case petitioners.      The

Cravenses’ lack of counsel also reduced the likelihood that they

would inform counsel for test case petitioners that their cases

had settled.

     (3) Before the trial of the test cases, McWade intentionally

misled the Court, with the complicity of DeCastro, by not

disclosing the settlement of the Thompson cases when he moved to

set aside the Thompson piggyback agreements.   At the trial of the

test cases, Sims, McWade, and DeCastro intentionally misled the

Court about the status of the Thompson cases by not disclosing

that they had been settled.   They intentionally misled the Court

in similar fashion about the Cravens cases.    McWade allowed

Alexander to offer misleading testimony denying that his tax

liabilities would be zeroed out in exchange for his testimony and

other assistance to McWade.

     (4) Izen had no knowledge, before and at the trial of the

test cases through the times that the Court issued the Dixon II

opinion and entered the initial decisions in the test cases, that

the Thompsons and the Cravenses had entered into settlement

agreements with McWade.   However, DeCastro did not act as a
                              - 58 -

Government “mole” during the trial of the test cases or convey

any of Izen’s trial strategies or confidential information to the

Government.

     Having made detailed findings of fact describing the

misconduct of the Government attorneys and DeCastro during the

test case proceedings, we evaluated that misconduct under Arizona

v. Fulminante, 479 U.S. 279, 309-310 (1991), as mandated by the

Court of Appeals, citing Chapman v. California, 386 U.S. 18

(1967), for the proposition that the presence of a structural

defect in a criminal trial requires automatic reversal of the

conviction and a new trial; we held that the misconduct of the

Government attorneys did not create a structural defect that

would invalidate the judgments in the test cases.22   We reasoned

that the Thompson and Cravens settlements did not alter the basic


     22
      In Dixon III, we observed that the term “structural
defect” normally refers to the violation of a fundamental
constitutional right occurring during a criminal trial that
affects the very framework within which the trial proceeds so
that the trial cannot reliably serve its function as a vehicle
for determination of guilt or innocence. Not all constitutional
errors occurring during a trial result in a structural defect in
the proceedings. In fact most constitutional errors,
characterized as lesser “trial errors”, are amenable to harmless-
error analysis. A constitutional violation is harmless if it did
not have a “‘substantial and injurious effect or influence’” in
determining the jury’s verdict. Rice v. Wood, 77 F.3d 1138, 1144
(9th Cir. 1996) (quoting Brecht v. Abrahamson, 507 U.S. 619, 623
(1993)). In civil cases an error related to admission of
evidence or attorney misconduct is considered harmless if there
is no prejudicial effect and/or the error did not affect the
judgment. See Chalmers v. City of Los Angeles, 762 F.2d 753,
761-762 (9th Cir. 1985); see also Mateyko v. Felix, 924 F.2d 824,
827-828 (9th Cir. 1991) (new trial is warranted only if
misconduct affected the verdict).
                              - 59 -

framework within which the trial of the test cases was conducted

and that the outcome of the retrial of the test cases would be

the same if we were to order a new trial.

      Next we considered the merits of the motions of intervention

filed by Kersting project nontest case petitioners whose cases

were bound by Dixon II.   We concluded that the Government

misconduct did not provide any other basis for invalidating the

Court’s decisions in the remaining test cases or for setting

aside the piggyback agreements.

      In Dixon III we found that the Kersting project nontest case

petitioners who signed piggyback agreements received what they

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

II.   We reviewed the Court’s Dixon II opinion and then considered

the relative importance of the testimony and evidence of the

Thompsons, the Cravenses, and the Alexanders to the Court’s

holdings in Dixon II.   In Dixon II the Court had relied upon

substantial objective evidence in concluding that the test case

petitioners had no business purpose for entering into the

Kersting programs other than tax avoidance and that the

transactions lacked economic substance.

      In Dixon III we held that the Government misconduct resulted

in harmless error in the trial of the test cases insofar as the

Court had concluded in Dixon II that:   (1) The Kersting

transactions were shams; (2) the Kersting promissory notes did
                              - 60 -

not constitute genuine debt; and (3) interest on Kersting loans

was not paid within the meaning of section 163(a).

     Because the outcome in the trial of the test cases would not

have changed had the Cravens and Thompson cases been removed from

the test case array, we concluded that the taxpayers were not

entitled to a new trial, concluding that the misconduct resulted

in harmless error rather than reversible error.   See Arizona v.

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

670, 678 (7th Cir. 1997), affg. T.C. Memo. 1995-209.

     In Dixon III we also held that the Government misconduct in

the trial of the test cases did not amount to fraud,

misrepresentation, or misconduct under rule 60(b)(3) of the

Federal Rules of Civil Procedure or fraud on the Court that would

require the Court either to order a new trial or to enter

decisions eliminating all tax liability.

     In Dixon III we found that the test case petitioners were

afforded a fair trial despite the Government misconduct,23 and

therefore justice would not be served if we were to adopt the

extraordinary remedy of renouncing the Court’s deficiency



     23
      Although we observed that respondent promptly reported
McWade’s and Sims’s misconduct to the Court upon discovery and
that respondent’s overall conduct in the proceedings exhibited
respondent’s institutional good faith, Dixon IV, 79 T.C.M. (CCH)
1803, 1810, 2000 T.C.M. (RIA) par. 2000-116, at 2000-641; Dixon
III, 77 T.C.M. (CCH) 1630, 1720, 1999 T.C.M. (RIA) par. 99,101,
at 99-652, we had no occasion in the Dixon III and IV proceedings
to examine or address the circumstances surrounding respondent’s
posttrial settlement offer.
                               - 61 -

determinations in Dixon II, thereby eliminating all tax liability

of the taxpayers.    Our conclusion that the misconduct was not a

fraud on the Court appeared to us to be consistent with the

DuFresne panel’s holding in Adair v. Commissioner, 26 F.3d 129

(9th Cir. 1994), that the decisions in the Cravens and Thompson

cases were final and that the Tax Court lacked jurisdiction to

vacate them.    Under Ninth Circuit precedent, the Tax Court has

jurisdiction to set aside a final decision where a fraud has been

perpetrated on the Court.    Toscano v. Commissioner, 441 F.2d at

934.

       We also concluded that the piggyback agreements executed by

Kersting project nontest case petitioners should not be set aside

under the theory of fraudulent inducement or for breach of

contract.

       Although we held in Dixon III that Kersting project test

case and nontest case petitioners were not entitled to a new

trial or the elimination of all their tax liabilities, we

recognized that the misconduct of McWade and Sims had harmed the

judicial process, and we found it appropriate to impose sanctions

against respondent under Rule 123(a).    We held that Kersting

project petitioners who either had not had decisions entered in

their cases or whose decisions had not yet become final were not

liable for the interest component of the addition to tax for
                              - 62 -

negligence under section 6653(a)(2) or (1)(B) or interest

computed at the increased rate prescribed in section 6621(c).

     In Dixon IV we imposed additional sanctions pursuant to

section 6673(a)(2)(B) by ordering respondent to pay the

attorney’s fees the Kersting project petitioners had incurred to

investigate McWade’s and Sims’s misconduct and present the

evidence of that misconduct to the Court.   We also held that

further sanctions against respondent were not warranted to reduce

Kersting project petitioners’ tax liabilities to match

respondent’s earlier 20-percent settlement offer.   The remaining

test case petitioners (except the Thompsons, the Cravenses, and

Rina24) and the Kersting project nontest case petitioners who had

participated in the evidentiary hearing mandated by DuFresne

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

Circuit.

     C.    Gridley v. Commissioner

     The Gridleys and the Fleers, nontest case Kersting project

petitioners who were bound by the outcome of the test cases

through piggyback agreements, filed motions for summary judgment

that they were entitled to entry of decisions providing for zero

deficiencies, consistent with the decision entered in the

Thompsons’ case for 1979, docket No. 19321-83 (all versions of


     24
      On June 13, 1995, shortly before the evidentiary hearing
on remand from DuFresne, Rina agreed to entry of a stipulated
decision in the amounts respondent originally determined in his
deficiency notice.
                                - 63 -

the Thompson settlement applied the burnout to provide a zero

deficiency for 1979, the Thompsons’ first taxable year), citing

Estate of Satin v. Commissioner, T.C. Memo. 1994-435, and Fisher

v. Commissioner, T.C. Memo. 1994-434.    We denied their motions in

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

Estate of Satin and Fisher on the ground that the piggyback

agreements in those cases bound the taxpayers to the resolution

of the test cases “whether by litigation or settlement”, whereas

the Gridleys’ and Fleers’ piggyback agreements did not mention

settlement of the test cases.    The Gridleys and Fleers appealed

to the Court of Appeals for the Ninth Circuit; by mandate dated

May 6, 2003, the Court of Appeals remanded for further

proceedings consistent with Dixon V.25

     D.   Dixon V:   Court of Appeals Again Reverses and Remands

     Consistent with the concluding statement in DuFresne v.

Commissioner, 26 F.3d at 107, that all subsequent appeals would

be scheduled before the DuFresne panel, the DuFresne panel, on


     25
      By orders entered July 11, 2000, we had certified the
Gridley and Fleer cases, as well as the cases of nontest case
Kersting project who had participated in the evidentiary hearing,
for interlocutory appeal to the Court of Appeals for the Ninth
Circuit. The Court of Appeals permitted those appeals. However,
the Court of Appeals thereafter stayed appellate proceedings in
all the appealed nontest cases, while briefing, argument, and
review of the appeals in the test cases went forward. After its
Dixon V opinion, the Court of Appeals, recognizing that the
Gridley and Fleer cases were related to the Dixon cases and the
other nontest cases, remanded the Gridley and Fleer cases and the
other nontest cases to this Court for further proceedings
consistent with Dixon V.
                                   - 64 -

November 21, 2001, set the original briefing schedule for the

appeals of Dixon III and IV and received the opening and reply

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

that “Upon reconsideration of the original panel that heard this

matter will not retain jurisdiction of any subsequent appeals.

Accordingly, the Clerk of the court is hereby directed to

schedule the current appeal in the normal course of events”.           The

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

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

arguments.

     On January 17, 2003, the Dixon V panel issued Dixon V

(amended March 18, 2003), vacating and remanding the Tax Court’s

decisions in the remaining test cases.        Dixon v. Commissioner,

316 F.3d 1041 (9th Cir. 2003).        The Court of Appeals held we had

applied the wrong law in Dixon III26 and held the misconduct of

McWade and Sims was a fraud on both the Kersting project

petitioners and the Tax Court, “a fraud, plainly designed to

corrupt the legitimacy of the truth-seeking process”.         Id. at

1046.        “Fraud on the court occurs when the misconduct harms the

integrity of the judicial process, regardless of whether the

opposing party is prejudiced.”        Id. (citing   Alexander v.

Robertson, 882 F.2d 421, 424 (9th Cir. 1989)).        The Court of



        26
      Dixon V distinguished and held inapplicable the contrary
decision of the Court of Appeals for the Seventh Circuit in
Drobny v. Commissioner, 113 F.3d 670, 678 (7th Cir. 1997).
                                  - 65 -

Appeals held that the fraud not only defiled the sanctity of the

Court and the confidence of all future litigants, but also

violated the rights of more than 1,300 Kersting project

petitioners who had agreed to be bound by the outcome of the test

cases.    Id. at 1047.

     Rather than ordering a new trial or entering decisions

eliminating all tax liabilities of the Kersting project

petitioners, the Court of Appeals directed that terms equivalent

to those provided in the Thompson settlement agreement be

extended to “Appellants and all other taxpayers properly before

this Court”.27   Id.     The Court of Appeals left to the Tax Court’s

discretion “the fashioning of such judgments which, to the extent

possible and practicable, should put these taxpayers in the same

position as provided for in the Thompson settlement.”      Id. n.11.

     On January 17, 2003, the same day as its original Dixon V

opinion, the Court of Appeals filed its primary mandate,

reversing and remanding with directions.      On May 28, 2003, the

Court of Appeals, acting through the Dixon V panel, filed a

supplemental mandate sending the test case petitioners’ appellate

fee requests to the Tax Court for a determination of entitlement




     27
      In setting forth the factual background and procedural
history of the Kersting project, the Court of Appeals noted
without comment that several hundred taxpayers had settled their
cases. Dixon V at 1043.
                                - 66 -

and, if warranted, amount.28    The supplemental mandate also stated

that the Dixon V panel “retains jurisdiction over all further

proceedings that may arise”.

     E.      Responses to Dixon V by the Office of Chief Counsel

     On January 21, 2003, at the annual meeting of the New York

State Bar Association Tax Section, then IRS Chief Counsel B. John

Williams (Williams) spoke about the role of the professional

adviser in preserving the public’s confidence in our tax system.

See B. John Williams, Jr., Chief Counsel, Internal Revenue

Service, Remarks at the Meeting of the New York State Bar

Association Tax Section (Jan. 21, 2003), in 2003 TNT 15-20,

excerpts from which are set forth in appendix A.       Williams said

that he expected attorneys in the Office of Chief Counsel to

adhere to the highest professional standards.     He discussed the

fraud committed on the Tax Court in the Kersting test case

proceedings and his endorsement of the opinion and mandate of the

Court of Appeals in Dixon V.     He announced that the Office of

Chief Counsel would “expeditiously implement the Ninth Circuit’s

mandate to extend to all affected taxpayers the terms of the

settlement that were effected in the lead test case.      We will

also assure that no interest is charged on deficiencies for the

period of the appeals to the Ninth Circuit.”     Id.




     28
          See supra note 3.
                              - 67 -

     Williams acknowledged that the goal of IRS attorneys cannot

be to collect the most revenue for the Government or to win cases

at all costs.   Rather, the goal is to ensure that the tax system

is administered fairly and impartially.   He recognized that

“confidence in the integrity and fairness of the tax system is

vital to our democracy.   The tax system touches more people in

this country than any other part of the government or our laws.

The loss of confidence in its integrity is the loss of confidence

in the government itself.”   Id.

     On February 3, 2003, Deborah Butler, IRS Associate Chief

Counsel for Procedure and Administration, issued Chief Counsel

Notice CC-2003-008 (excerpts set forth in appendix B), reminding

all Chief Counsel attorneys, in the light of the opinion of the

Court of Appeals in Dixon V, of their obligation to adhere to the

highest ethical standards when performing their duties, including

representing the IRS before the Tax Court.   The notice reminded

Chief Counsel attorneys that their role is to ensure the uniform

application of the tax laws and the fair disposition of cases and

that, as officers of the court, they have a special duty to avoid

conduct that undermines the integrity of the adjudicative

process.   Chief Counsel attorneys must ensure that their actions

(or failure to act) preserve the sanctity of the court and

safeguard the public’s confidence in the judicial process.     Id.
                               - 68 -

     The notice explained that Chief Counsel attorneys must

conduct their activities in accordance with the letter and spirit

of the Model Rules of Professional Conduct of the American Bar

Association (ABA Model Rules).   The notice specifically discussed

ABA Model Rules 4.1 and 8.4.   ABA Model Rule 4.1 provides in part

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

knowingly make a false statement of material fact or law to a

third person, or fail to disclose a material fact when disclosure

is necessary to avoid assisting a criminal or fraudulent act by a

client, unless disclosure is prohibited under ABA Model Rule 1.6

regarding client-lawyer confidentiality.   It is also professional

misconduct under ABA Model Rule 8.4 for a lawyer to engage in

conduct involving dishonesty, fraud, deceit or misrepresentation

or to engage in conduct that is prejudicial to the administration

of justice.

     The notice concluded:   “All Chief Counsel attorneys are

expected to carry out their responsibilities with the utmost

integrity.    Clearly, the conduct of the Chief Counsel attorneys

in Dixon fell far short of those high standards.”   CC-2003-008.

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

     Our Dixon VI opinion responded to the directions of the

Dixon V opinion and primary mandate to determine how the Thompson

settlement would be imposed against respondent in favor of the

test case petitioners and all parties properly before the Court.
                             - 69 -

In Dixon VI, we held that: (1) The final Thompson settlement is

to be regarded as resulting in a 63.37-percent reduction of the

Thompsons’ deficiencies, as well as elimination of all

Kersting-related penalties and additions; (2) the Thompson

settlement encompasses and requires the vacating of the portion

or portions of the deficiencies determined against any Kersting

project petitioners that may be attributable to the “Bauspar”

shelter that was also promoted by Kersting; (3) the Thompson

settlement’s cancellation of the Thompsons’ 1981 late-filing

addition justifies cancellation of not only all

non-Kersting-related penalties and additions but also all other

substantive adjustments not arising from shelters promoted by

Kersting; (4) interest on the reduced deficiencies shall not be

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

concession.29


      29
      Respondent conceded that the accrual of interest on
Kersting project deficiencies ultimately determined by this Court
should be tolled as of June 1992, in accordance with the Jan. 21,
2003 public announcement of then IRS Chief Counsel B. John
Williams. In a speech on that date at the annual meeting of the
New York State Bar Association Tax Section, Williams assured the
public that no interest would be charged on Kersting project
deficiencies for the period of the appeals. As indicated by
Dixon VI n.30: “The original decisions in Dixon II were entered
Mar. 13, 1992; the [original] notices of appeal were filed May
14, 1992; the 90-day appeal period would have expired June 11,
1992.” Stipulated decisions and decisions entered under Rule 155
following Dixon VI and VIII provide that “No interest shall
accrue [on deficiencies] during the period from May 14, 1992,
through the date that is 90 days after the decision in this case
is entered.” Motions are pending before the Tax Court in 16
cases of Kersting project nontest case petitioners with
                                                   (continued...)
                              - 70 -

     Respondent and the Kersting project petitioners had agreed

in a stipulation of settled issues that the relief extended to

all docketed cases in the Kersting project remaining open,

whether or not the Kersting project petitioners had signed

piggyback agreements.30

     In Dixon VIII we denied the motion of the Hongsermeier test

case petitioners for reconsideration of Dixon VI.    The

Hongermeiers alleged that respondent engaged in attempts at a

continued coverup of the fraud of respondent’s attorneys, and

they asked the Court to impose additional sanctions on respondent

for respondent’s alleged continued misconduct.31    The alleged



     29
      (...continued)
deficiencies, as of Sept. 13, 2007, in cases in which decisions
giving effect to the Thompson settlement have not yet been
entered, to stop further accrual of interest on their
deficiencies after Sept. 13, 2007.
      30
      Dixon VI, 91 T.C.M. (CCH) at 1107, 2006 T.C.M. (RIA) par.
2006-090, at 2006-671.
      31
      Kersting project petitioners who settled their cases and
have filed motions for leave to file motions to vacate (see Part
VIII infra) make similar allegations. They ask the Court to
conduct an evidentiary hearing to determine whether, following
the trial of the test cases, the conduct of respondent’s
management related to the posttrial settlement offer continued
the fraud on the Court (or constituted a new fraud on the Court)
and, if the Court so finds, to impose the Dixon V sanction on
respondent for that conduct. Another evidentiary hearing is
unnecessary because of our holding herein that the fraud
committed on the Court by respondent’s counsel during the test
case proceeding was a fraud on the Court in the case of every
Kersting project petitioner who was bound by the test cases and
that the Dixon V sanction is to be imposed against respondent in
each such case. We impose sanctions in all cases where decisions
                                                   (continued...)
                              - 71 -

misconduct of respondent’s managers following the trial of the

test cases was directly in issue in the prior proceedings before

this Court in the DuFrense remand and before the Court of Appeals

in the Dixon V appeal.   We therefore held that the issue of any

continuing misconduct was covered by necessary implication by the

opinion of the Court of Appeals in Dixon V and by its most recent

primary mandate.   In Dixon VIII, we concluded that the law of the

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

precluded us from conducting any further inquiry into

respondent’s misconduct and from imposing any additional sanction

on respondent with respect to cases of Kersting project

petitioners who were properly before the Court of Appeals.

     The Hongsermeiers (represented by Minns) and Kersting

project petitioners in 12 other test and nontest cases

(represented by Izen and Sticht) have appealed to the Court of

Appeals for the Ninth Circuit our decisions giving effect to the

Thompson settlement sanctions as formulated in our Dixon VI and

VIII opinions.

     In Dixon VII and Young v. Commissioner, T.C. Memo. 2006-189,

we responded to the Dixon V supplemental mandate with regard to

Kersting project petitioners’ appellate attorney’s fees and costs

incurred in Dixon V.   We have determined that both test case and



     31
      (...continued)
were entered on or after June 10, 1985, the date the Court agreed
to use the test case procedure in the Kersting project cases.
                                  - 72 -

nontest case Kersting project petitioners represented by various

counsel are entitled to appellate attorney’s fees and have

determined the amounts of those fees.

     The Court now has under consideration various Kersting

project petitioners’ applications for post Dixon V attorney’s

fees and costs incurred in the Dixon V remand proceedings.

VIII.        Motions To Vacate

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

which stipulated decisions were entered both before and after

respondent’s discovery and disclosure to the Court of McWade’s

and Sims’s misconduct, Kersting project petitioners have filed

motions for leave to file motions to vacate the decisions.

Petitioners and the other Kersting project petitioners filing or

attempting32 to file such motions seek new decisions reflecting

the benefits of the Thompson settlement as mandated by the Court

of Appeals in Dixon V.       The Lewises, in their motions, ask us to

vacate their stipulated decisions so they can “participate in the

benefits to be generated by the subsequent proceedings mandated

by the Court of Appeals in Dixon V”.       In Lewis v. Commissioner,

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

file motions to vacate stipulated decisions.

     In Lewis, we focused on the legal consequences of the

Lewises’ acceptance of respondent’s posttrial settlement offer,


        32
      The Court has returned unfiled numerous other such motions
because of procedural defects.
                             - 73 -

applying general principles of contract law.   We found that the

Lewises, who settled after respondent disclosed the secret

settlements to the Court, abandoned any opportunity to benefit

from the mandate of the Court of Appeals in Dixon V, issued 10

years after respondent’s posttrial settlement offer.   We found

that knowledge of the Lewises and their counsel of the secret

settlements and allegations of fraud on the Court made in the

appeals of Dixon II filed in the Court of Appeals for the Ninth

Circuit precluded a claim of fraud and that, by settling as they

did, the Lewises assumed the risk that, as a result of the then-

pending appeals, other Kersting project petitioners might become

entitled to a more favorable outcome.

     The Lewises timely filed motions for reconsideration.    We

now believe that we applied the wrong law in Lewis, as the Court

of Appeals in Dixon V held we did in Dixon III and IV, and that

we failed to appreciate and apply the full scope of the holding

of Dixon V in accordance with its rationale.   We have therefore

granted the Lewises’ motions for reconsideration, granted the

motions for leave in the Lewis, Hartman, and Liu cases, and

consolidated them for the purpose of this opinion, in which we

hold that the underlying motions to vacate should be granted.
                                - 74 -

                              Discussion

I.   Preliminary Comments

     Respondent, Kersting project petitioners, the opinion-

reading public, and the Court of Appeals for the Ninth Circuit

might well consider this opinion a surprising about-face from our

opinion in Lewis v. Commissioner, supra.     We therefore indicate

some of the considerations that have led to our change of

position.

     Hartman’s and the Lius’ motions for leave to vacate and the

Lewises’ motions for reconsideration led us to reread the Dixon V

opinion.     Our rereading prompted us to compare the different

situations of the 400-500 settling Kersting project petitioners,

who at various times were induced to agree to entry of stipulated

decisions, with the situations of the more than 1,300 nonsettling

petitioners who have delayed entry of decisions in their cases

through the appeal process in the Court of Appeals for the Ninth

Circuit.33


      33
      These more than 1,300 Kersting project petitioners have
sorted into three groups: (1) Those who, after issuance of our
opinions in Dixon VI and VIII responding to the mandate of Dixon
V to determine and apply the Thompson settlement to the Kersting
project cases, have agreed to entry of stipulated decisions in
accordance with our opinions in Dixon VI and VIII and waived
their appeal rights; (2) those who have had decisions entered in
accordance with the terms of the Thompson settlement as
determined by our opinions in Dixon VI and VIII, and have filed
appeals to the Court of Appeals for the Ninth Circuit; and (3)
those who continue to await the final outcome of those test cases
that have been appealed to the Court of Appeals for the Ninth
Circuit. We assume that all Kersting project test cases and
                                                   (continued...)
                                 - 75 -

     The observation of the Court of Appeals in Dixon V that the

misconduct of respondent’s attorneys violated the rights of all

petitioner participants in the Kersting project to a fair trial

of the test cases brought home to us more keenly than we had

previously appreciated that our Lewis opinion would result in

disparate treatment of those who have agreed to entry of

stipulated decisions at various times along the way, as compared

with those who have awaited the final outcome.      We had a visceral

reaction that our Lewis opinion violated some sense of

distributive justice,34 whether derived from notions of equality35

or of fairness,36 and that the Dixon V opinion and mandate

required a contrary result.      Recognizing the incompatibility of

the various formulations of distributive justice by political

philosophers over the years,37 we mention those formulations as no



     33
      (...continued)
nontest cases on appeal to the Court of Appeals for the Ninth
Circuit will be reviewed by the panel that issued the opinion in
Dixon V. See supra note 5 and accompanying text.
      34
      See Aristotle, “Nichomachean Ethics”, bk. V, chs. 2 and 3,
Introduction to Aristotle (Richard McKeon, ed., Modern Library
1947). Aristotle’s original formulation of distributive justice
in terms of the relative merits or virtuousness of the
individuals among whom goods are to be apportioned might be
deemed to be more in line with our opinion in Lewis, than the
more recent formulations mentioned infra notes 35 and 36.
      35
      See Hobbes, Leviathan (1651), ch. xv, at 208 (Pelican
Classics 1968).
      36
           See Rawls, A Theory of Justice (rev. ed. 1999).
      37
           See MacIntyre, After Virtue, 246-257 (2d ed. 1984).
                             - 76 -

more than intimations that we should reconsider our Lewis

position in the light of our rereading of the Dixon V opinion.

Those intimations have led us to reflect on the various

situations of those Kersting project petitioners who were part of

the test case proceedings and who agreed to entry of stipulated

decisions at different times along the way after the test case

proceedings began.38

     First, there are Kersting project petitioners who settled

with respondent before the misconduct had begun or who, like

Hartman, settled after the misconduct had begun but before the

Court issued Dixon II and before respondent’s management

discovered the misconduct and disclosed it to the Court.    Such

petitioners, irrespective of whether they had concluded that

their position on the merits was well-nigh hopeless or had some

chance of success, were entitled to assume that the test cases

whose outcome would determine the tax effects of the Kersting

programs would be well and fairly tried.   That assumption was

defeated by McWade’s and Sims’s intervening misconduct.

     Second, there is a small group of Kersting project

petitioners who agreed to entry of stipulated decisions during

what respondent calls the “gap period”, after the Court issued


     38
       Any Kersting project taxpayers who settled with respondent
before the Court agreed to use the test case procedure in
resolving the bulk of the Kersting project cases were not part of
the test case proceedings. Those taxpayers were not affected by
the fraud on the Court, and sanctions are not warranted in their
cases.
                              - 77 -

Dixon II and before respondent’s management discovered the

misconduct and disclosed it to the Court.   Respondent has

conceded that Kersting project petitioners in this category are

entitled to have their stipulated decisions vacated so they can

avail themselves of the benefits of the Thompson settlement.39

     Third, there were Kersting project petitioners, such as the

Lius and the Lewises, who accepted the reinstated project

settlement offer after respondent had disclosed the misconduct to

the Court, and who, actually or through counsel, had or may have

become aware of the Cravens and Thompson settlements and of the

pending appeals.   However, they may well have been discouraged by

the Court’s denial of respondent’s motion for an evidentiary

hearing and his conclusion that the misconduct had not affected

the outcome of the test cases.   They may have been disheartened


     39
      Respondent has made this concession on the record in Kahle
v. Commissioner, docket Nos. 24558-84 and 38976-84, cases in
which stipulated decisions conceding respondent’s adjustments in
full were entered in the “gap period” with respect to which
petitioner has filed motions for leave to file motions to vacate.
On Oct. 2, 1991, Terrence Kahle (Kahle), proceeding pro se,
contacted McWade conceding the Kersting issues and requesting
that McWade send decision documents. McWade sent decision
documents to Kahle on Oct. 9, 1991, and Kahle signed them on Dec.
20, 1991, 9 days after the Court published Dixon II. The
decisions in Kahle’s cases were entered on Jan. 6, 1992, and
became final before respondent discovered the misconduct of
McWade and Sims and disclosed it to the Court. On Feb. 24, 1994,
respondent administratively abated Kahle’s deficiencies and
additions and attempted to give him the benefit of the 7-percent
reduction of the posttrial settlement offer. Respondent has
conceded that the stipulated decisions entered in Kahle’s cases
and any other stipulated decisions entered during the gap period
should be vacated and new decisions entered in accordance with
Dixon VI.
                               - 78 -

by the Court’s apparent failure to appreciate or consider that

McWade’s and Sims’s conduct was unethical and fraudulent and

puzzled by respondent’s failure to appeal the Thompson and

Cravens decisions.   Again, they were probably further discouraged

by our denials of the timely motions to intervene filed in the

Thompson and Cravens cases by Attorneys Sticht and Izen on behalf

of their nontest case petitioner clients.

     These developments were soon followed by respondent’s

reinstatement of the lowball nuisance value project settlement

offer, an offer that intentionally did not disclose that it was

much less favorable to Kersting project petitioners than the

final secret Thompson settlement and failed to disclose and

acknowledge to the public that the settlement and its having been

kept secret were improper, much less admit the dimensions and

seriousness of the intervening misconduct.   Although the offer

stated that the Court had decided that the settlements did not

change the results in Dixon II, it failed to acknowledge that

Dixon II was being appealed.   The offer also failed to

acknowledge that allowing the Thompsons a settlement that

provided them more favorable treatment than other taxpayers and

compensating the Thompsons for their attorney’s fees violated IRS

policy and the Department of the Treasury Minimum Standards of

Conduct.   While the offer claimed it was being made in fairness

to Kersting project petitioners, acceptance of the offer

continued and confirmed the disparate treatment of the accepting
                              - 79 -

petitioners in comparison to both the Thompsons and the Chicoine

and Hallett and DeCastro clients who had obtained 20-percent

reduction settlements.

     The reinstated offer was merely an attempt at damage

control; it did not purge the fraud that besmirched every case

that was part of the Kersting project test case proceedings; it

did not mitigate the harm caused by that fraud.   The offer left

the Lius, the Lewises, and more than 400 other Kersting project

petitioners with the overwhelming impression that, realistically

speaking, respondent’s lowball nuisance value reinstated project

settlement offer was the only game in town, and that it was

generous because in all likelihood the adverse decisions against

the test case petitioners would be sustained on appeal.40

     This impression was confirmed by the opinion of the Court of

Appeals on the first appeal in DuFresne v. Commissioner, 26 F.3d

105 (9th Cir. 1994), which seemed to ignore the fraud on the

court arguments made to it by Attorney Izen--even as it remanded

for an evidentiary hearing to determine the extent of the



     40
      Our pejorative characterization of respondent’s
reinstatement of the project settlement offer following the
misconduct of respondent’s attorneys in the Kersting test cases
should not be seen as the Court’s view of the Commissioner’s use
of such an offer to settle cases in other tax shelter projects
where, in the Commissioner’s view, the shelter lacks merit. It
is not the province of the courts to second-guess the
Commissioner’s exercise of professional judgment in doing his
job. See United States v. Payner, 447 U.S. 727, 737 (1980)
(Burger, C.J., concurring) (Supreme Court has no general
supervisory authority over executive branch operations).
                                - 80 -

misconduct--by couching the analysis in terms of structural

defect versus harmless error.    The same panel, in its unpublished

opinion in Adair v. Commissioner, 26 F.3d 129 (9th Cir. 1994),

affirming our denial of Sticht’s and Izen’s motions for

intervention in the Thompson and Cravens cases, appeared to

ignore the possibility of fraud on the court when it held that

the Thompson and Cravens decisions had become final; this would

not have been so had the panel recognized that the misconduct

might have been a fraud on the court.    See Toscano v.

Commissioner, 441 F.2d at 934.    In the same vein, our opinions in

Dixon III and IV responded to the mandate of DuFresne by applying

traditional harmless error analysis to hold that the misconduct

of respondent’s attorneys did not entitle the test case

petitioners (and, by extension, all Kersting project petitioners)

to any substantial relief other than remission of additions and

awards of attorney’s fees.   Dixon V held that our focus on

harmless error analysis was wrong at every turn.

     The foregoing observations have also led us to consider the

career of Justice Holmes’s famous dictum:   “Men must turn square

corners when they deal with the Government.”    Rock Island, Ark. &

La. R.R. Co. v. United States, 254 U.S. 141, 143 (1920).      The

phrase originated in a tax refund case holding that taxpayers

must comply with even formal statutory conditions to the

Government’s consent to be sued; its subsequent invocations have

led to judicial recognition of the correlative proposition that
                              - 81 -

Government officials have some minimum substantive obligations to

the citizens they have been hired to serve.   Even as the Supreme

Court continued strictly to limit claims of estoppel against the

Government, it recognized that citizens have an interest in “some

minimum standard of decency, honor, and reliability in their

dealings with their Government”, see Heckler v. Comty. Health

Servs., Inc., 467 U.S. 51, 61 (1984); that “when the Government

acts in misleading ways, it may not enforce the law if to do so

would harm a private party as a result of governmental

deception”, id. n.12 (citing United States v. Pa. Indus. Chem.

Corp., 411 U.S. 655, 670-675 (1973), and Moser v. United States,

341 U.S. 41 (1951)); and that “‘Men naturally trust in their

government, and ought to do so, and they ought not to suffer for

it’”, id. n.13 (quoting Menges v. Dentler, 33 Pa. 495, 500

(1859)).   These usages were preceded by observations in dissent

that “there is no reason why the square corners should constitute

a one-way street”, FCIC v. Merrill, 332 U.S. 380, 387-388 (1947)

(Jackson, J., dissenting), and “It is no less good morals and

good law that the Government should turn square corners in

dealing with the people than that the people should turn square

corners in dealing with their Government”, St. Regis Paper Co. v.

United States, 368 U.S. 208, 229 (1961) (Black, J., dissenting),

that have more recently been quoted in support of deciding a

claim against the Government, see United States v. Winstar Corp.,

518 U.S. 839, 886 n.31 (1996);   see also Commissioner v. Lester,
                                - 82 -

366 U.S. 299, 306 (1961) (Douglas, J., concurring) (“The revenue

laws have become so complicated and intricate that * * * the

Government in moving against the citizen should also turn square

corners.”).

     To quote from former Chief Counsel Williams’s address to the

annual meeting of the New York State Bar Association Tax Section

in January 2003 (appendix A):

          The public’s confidence in our tax system rests,
     in significant part, on their perception of fairness in
     the administration of the tax laws. This begins with
     government first. * * * Fraud on any court is, in my
     view, not only pernicious to the fair resolution of the
     particular case, but also threatening to fundamental
     democratic principles. As an institution, the Office
     of Chief Counsel must adhere to the highest standards
     of conduct not simply conform to minimum professional
     obligations.

     As the Court of Appeals for the Ninth Circuit said in Brandt

v. Hickel, 427 F.2d 53, 57 (9th Cir. 1970) (also quoted in

Heckler v. Comty. Health Servs., Inc., supra at 61 n.13), “To say

to these appellants, ‘The joke is on you.   You shouldn’t have

trusted us,’ is hardly worthy of our great Government.”   To tell

Kersting project petitioners they should not have trusted

respondent to try the test cases honestly and fairly and the Tax

Court to formulate an appropriate sanction when respondent failed

to do so would be equally unworthy.

     In Dixon V, the Court of Appeals held that the fraud on the

Court committed by McWade and Sims during the Kersting test case

proceedings violated the rights of all Kersting project
                                - 83 -

petitioners “who agreed to be bound by the outcome of the Tax

Court proceeding”.     Despite the foregoing catalog of missed

opportunities, it is not too late to rectify our errors.     “Wisdom

too often never comes, and so one ought not to reject it merely

because it comes late.”     Henslee v. Union Planters Natl. Bank &

Trust Co., 335 U.S. 595, 600 (1949) (Frankfurter, J.,

dissenting).     Having responded in Dixon VI and VIII to the

primary mandate of the Court of Appeals in Dixon V by fixing the

terms of the Thompson settlement that define the sanctions and

relief to which nonsettling Kersting project petitioners in more

than 1,300 dockets have become entitled, we hold that Kersting

project petitioners in the cases at hand and in more than 400

other dockets who agreed to entry of stipulated decisions are

entitled to the same sanctions and relief.

II.   Analysis

      We begin by reviewing the extent of the fraud committed on

the Court, the harm done thereby, and the sanction mandated by

the Court of Appeals in Dixon V to rectify the harm.     Second, we

reconsider Lewis v. Commissioner, T.C. Memo. 2005-205, by

applying to the cases at hand the findings, rationale, and

holding of the Court of Appeals in Dixon V.     Third, we explain

why respondent’s posttrial disclosure of McWade’s and Sims’s

misconduct did not purge the fraud from the test case

proceedings.     Fourth, we identify respondent’s obligations to the

Kersting project petitioners bound by the test cases and explain
                                - 84 -

why respondent’s posttrial settlement offer did not satisfy those

obligations.    Fifth, we explain why respondent’s posttrial

settlement offer (1) did not rectify the harm caused by the fraud

committed on the Court and (2) does not otherwise preclude this

Court from imposing sanctions for that fraud in cases of Kersting

project petitioners who accepted the offer.    Finally, we

formulate and prescribe a plan for expeditious implementation of

the sanctions and relief in all closed cases where stipulated

decisions were entered before we issued our Dixon VI and VIII

opinions.

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

     In Dixon V at 1045, the Court of Appeals for the Ninth

Circuit held that the misconduct of McWade and Sims during the

test case proceedings, including its persistence and concealment,

was a fraud on the Tax Court.    “Fraud on the court occurs when

the misconduct harms the integrity of the judicial process,

regardless of whether the opposing party is prejudiced.”       Id. at

1046 (citing Alexander v. Robertson, 882 F.2d at 424).

     McWade and Sims perpetrated a fraud on the Court that harmed

the integrity of the judicial process.    That judicial process was

the test case procedure that the parties, with the Tax Court’s

participation and encouragement, invoked in their efforts to

resolve the more than 1,800 cases arising from respondent’s
                              - 85 -

disallowance of deductions claimed by participants in the

Kersting programs.

     When the Court, taxpayers, and the IRS agree to employ the

test case procedure, the taxpayers whose cases are bound (whether

by piggyback agreement or the Court’s order to show cause

procedure) by the outcome of the test cases expect (and have a

right to do so) that the test cases will be well and fairly

tried.   The fraud on the Court committed by McWade and Sims in

the Kersting project test cases violated the rights of all

Kersting project petitioners who were bound by the outcome of the

test case proceedings and betrayed the confidence of all future

litigants in the test case procedure.   Id. at 1047.   The test

case procedure is a valuable judicial procedure, and, as the

Court of Appeals recognized, the continued viability of that

procedure requires the confidence of all future litigants.

     The fraud on the Court committed by respondent’s attorneys

in the Kersting project test cases violated the rights of not

only the test case petitioners but every petitioner whose case

was bound by the outcome of the test cases.   The fraud committed

by McWade and Sims was a fraud on the Court in every one of those

cases.

     The appropriate sanction against respondent for the fraud

committed on the Court by McWade and Sims should remedy the harm

done to the judicial process, restore public confidence in the

test case proceedings, rectify the violation of the rights of the
                                - 86 -

Kersting project petitioners whose cases were bound by the

outcome of the test cases, and deter future violations by the

offending party.     After expressing indignation at the odiousness

of the Government attorneys’ misconduct and the Tax Court’s

repeated failures to “get it right”, the Court of Appeals

formulated and mandated an intermediate sanction that provides

both an appropriate remedy for the violation of the rights of

Kersting project petitioners and an effective deterrent to

further misconduct by Government attorneys.     Holding the limited

sanctions we initially imposed in Dixon III and IV to be grossly

inadequate, but recognizing that the power to sanction is to be

“‘exercised with restraint and discretion’”, Dixon V at 1047

(quoting Roadway Express, Inc. v. Piper, 447 U.S. 752, 764

(1980)), the Court of Appeals held that it would be inappropriate

to force the taxpayers to endure a remand for a trial on the

merits,41 but also declined to enter judgment eradicating all tax

liability of the Kersting project petitioners--“Such an extreme

sanction, while within the court’s power, is not warranted under

these facts.”     Id. at 1047 (citing Chambers v. NASCO, Inc., 501

U.S. 32, 45 (1991)).

     The Court of Appeals recognized that the fraud on the court

committed by respondent’s attorneys in the Kersting project test

cases was a fraud on the court in every case bound by the outcome



     41
          Which the taxpayers would inevitably have lost.
                              - 87 -

of the test cases and sanctioned respondent in each of those

cases before the Court of Appeals.     The Court of Appeals held

that the appropriate remedy to be applied to all Kersting project

petitioners who were bound by the test cases (test case and

nontest case petitioners alike) properly before it was to enter

decisions that put them, as nearly as possible, in the same

position as provided for in the Thompson settlement.     Id. at 1047

n.11.   Putting every Kersting project petitioner (test case and

nontest case petitioners alike) whose cases were part of the test

case proceedings in the same position as provided for in the

Thompson settlement is the appropriate remedy for the violation

of their rights and the sanction that should have the necessary

deterrent effect.

     We have granted petitioners leave to file and petitioners

have filed motions to vacate the stipulated decisions entered in

their cases.   In effect, they have asked the Court to impose on

respondent in their cases the sanction mandated by the Court of

Appeals in Dixon V.   Motions in this Court to vacate or revise a

decision are covered by Rule 162, which provides:     “Any motion to

vacate or revise a decision, with or without a new or further

trial, shall be filed within 30 days after the decision has been

entered, unless the Court shall otherwise permit.”     Rule 162

provides no guidance as to when this Court will grant leave to

file a motion to vacate more than 30 days after a decision is
                              - 88 -

entered or, more importantly, when this Court will grant a motion

to vacate.

     A stipulated decision falls within the purview of Rule

91(a), which requires parties to stipulate “all matters not

privileged which are relevant to the pending case, regardless of

whether such matters involve fact or opinion or the application

of law to fact.”   The stipulation process has broad scope and is

not confined to the stipulation of facts or evidence.     Willamette

Indus., Inc. v. Commissioner, T.C. Memo. 1995-150 (citing

Explanatory Note to Rule 91(a), 60 T.C. 1118).    “The Court will

not permit a party to a stipulation to qualify, change, or

contradict a stipulation in whole or in part, except that it may

do so where justice requires.”   Rule 91(e) (emphasis added).

Where Rule 91(e) applies, the Tax Court must proceed in

accordance with the provisions of that Rule.     Farrell v.

Commissioner, 136 F.3d 889, 893-897 (2d Cir. 1998), revg. and

vacating Spears v. Commissioner, T.C. Memo. 1996-341.     The Court

is reluctant to set aside a stipulated decision in absence of

fraud, mutual mistake of fact, or other like cause.     MacElvain v.

Commissioner, T.C. Memo. 1987-366 (citing Saigh v. Commissioner,

26 T.C. 171, 176 (1956), and Estate of Jones v. Commissioner,

T.C. Memo. 1984-53, affd. 795 F.2d 566 (6th Cir. 1986)).

     When a taxpayer files a motion to vacate a decision after it

has become final, our authority to vacate the decision, though

limited, may be exercised in situations where the taxpayers
                               - 89 -

establish the existence of a fraud on the Court.     Cinema ’84 v.

Commissioner, 122 T.C. 264, 270 (2004).    Fraud on the Court is a

fraud that harms the integrity of the judicial process.

Standard Oil Co. of Cal. v. United States, 429 U.S. 17 (1976);

Hazel-Atlas Glass Co. v. Hartford-Empire Co., 322 U.S. 238, 245

(1944).    Fraud on the court includes any unconscionable plan or

scheme that is designed to improperly influence the court in its

decision.    Abatti v. Commissioner, 859 F.2d 115, 118-119 (9th

Cir. 1988), affg. 86 T.C. 1319 (1986).    The limited definition of

fraud on the Court reflects the policy of putting an end to

litigation and serves the important legal and social interest in

preserving the finality of judgments.     Toscano v. Commissioner,

441 F.2d at 934.

     Recognizing that the fraud on the Court committed by

respondent’s trial attorneys (1) was a fraud on the Court in

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

and (2) violated the rights of all Kersting project petitioners

in those cases, we are convinced that justice will best be served

by vacating the stipulated decisions and imposing on respondent

the sanction mandated by the Court of Appeals in Dixon V.

     Respondent’s position in these cases is that Kersting

project petitioners are not entitled to the benefit of the final

Thompson settlement unless they can directly connect conduct

amounting to fraud on the Court to the decisions entered in their

cases.    Respondent does not object to vacating the decisions in
                               - 90 -

nontest cases that were entered after December 11, 1991, the date

the Court filed its Dixon II opinion, and before June 9, 1992,

the date respondent disclosed the misconduct of McWade and Sims

to the Court in the motions to vacate the decisions in the

Thompson, Cravens, and Rina test cases.    Respondent concedes that

decisions in Kersting project cases that were entered during that

“gap period” (see supra note 39 and accompanying text) were

obtained by fraud on the Court and that decisions in those cases

should be vacated.    Respondent agrees that taxpayers who agreed

to stipulated decisions “in possible reliance on Dixon II and in

apparent ignorance of the misconduct in the test cases” are

entitled to have their decisions vacated because of the fraud on

the Court.

     Respondent objects to vacating stipulated decisions in these

and other Kersting project cases that were entered before the

publication of Dixon II (such as the Hartman cases) or after the

discovery and disclosure to the Court of the misconduct of

respondent’s attorneys (such as the Lewis and the Liu cases).

Respondent objects to vacating decisions entered in these and

other similar cases on the ground that the misconduct of McWade

and Sims had no influence on those petitioners’ decisions to

settle their cases.

     Respondent contends that before Dixon II was issued no one

knew with absolute certainty how the Court would rule on the

merits of the Kersting programs and that implicit in prior
                               - 91 -

decisions to settle was petitioners’ belief that “they would lose

under a fairly tried case”.    In our view, petitioners,

irrespective of whether they had concluded that their position on

the merits was well-nigh hopeless or had some chance of success,

were entitled to assume that the test cases whose outcome would

determine the tax effects of the Kersting programs would be well

and fairly tried.   That assumption was defeated by McWade’s and

Sims’s intervening misconduct.

     Respondent contends that Kersting project petitioners such

as Hartman decided to settle independently of, and without any

possible attribution to, the misconduct that constituted a fraud

on the Court.   Respondent’s attempt to impose the conditions that

there be a direct causal link between the fraud committed on the

Court and petitioners’ decisions to settle their cases, that

petitioners must not have known of the secret settlements, and

that petitioners need to have relied on the Court’s Dixon II

opinion cannot be sustained.    Imposing those conditions would

require petitioners and every other Kersting project petitioner

bound by Dixon II to show prejudice.    The Court of Appeals made

it clear in Dixon V that entitlement to relief from a fraud on

the court does not require a showing of prejudice.

     With respect to Kersting project petitioners such as the

Lewises and the Lius, respondent contends that the holding of the

Court of Appeals in Dixon V that McWade and Sims had perpetrated

a fraud on the Court “was directed at the improper settlement
                              - 92 -

arrangement with the Thompsons as it related to the 1989 test

case trial.   It had nothing to do with settlements of cases

subsequent to the discovery and public disclosure by respondent

of that improper conduct.”

     Respondent’s contention ignores the holding of the Court of

Appeals that McWade’s and Sims’s misconduct violated the rights

of all Kersting project petitioners who were bound by the outcome

of the Tax Court proceeding and the need to impose a sanction

providing a remedy for those violations.   Moreover, there clearly

is a causal link between the fraud committed on the Court and the

posttrial settlement offer.   But for the misconduct of McWade and

Sims, respondent would not have made the offer or adjusted

administratively the accounts of Kersting project petitioners

whose cases were closed.   There is thus a causal link between the

fraud committed on the Court and respondent’s decision to make

the posttrial settlement offer.

     The sanction fashioned by the Court of Appeals provides both

an appropriate remedy for the violation of Kesting project

petitioners’ rights and a deterrent to further misconduct by

Government attorneys.   To give full effect to that deterrent in

the context of respondent’s overreaching in trying to take

advantage of the initial failure of this Court to provide an

appropriate remedy, 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 who
                              - 93 -

settled their cases, for whatever reasons at any time during the

test case proceedings, without an individualized inquiry in each

such case into petitioner’s actual knowledge and motivations.    As

the Court of Appeals said:

          Here, it plainly would be unjust to remand for a
     new, third trial. The IRS had an opportunity to
     present its case fairly and properly. Instead its
     lawyers intentionally defrauded the Tax Court. The Tax
     Court had two opportunities to equitably resolve this
     situation and failed. 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. [Dixon V at 1047.]

     In matters involving questions of practice and procedure for

which there is no applicable rule, Rule 1(b)42 permits the Judge

of this Court before whom the matter is pending to prescribe an

appropriate procedure.   See Ash v. Commissioner, 96 T.C. 459,

469-470 (1991).   Under appropriate circumstances, we may impose

sanctions that are designed to mitigate the effects of a party’s

misconduct.   See Rules 104(c), 123; Betz v. Commissioner, 90 T.C.

816, 823-824 (1988) (as a sanction for the Commissioner’s failure

to timely file an answer, the Court deemed established that the

Commissioner erred in determining that additional interest was

due under section 6621(c)); Vermouth v. Commissioner, 88 T.C.

1488, 1499 (1987) (Commissioner not permitted to introduce

evidence of fraud because of failure to timely file an answer);



     42
      Rule 1 was amended effective Sept. 20, 2005. The
identical provision was in Rule 1(a) before the amendment.
                                - 94 -

Straight v. Commissioner, T.C. Memo. 1997-569 (although the

taxpayer was not prejudiced in presenting the merits of his case

by the misconduct of the Commissioner’s revenue agent, the Court

imposed a monetary sanction on the Commissioner in favor of the

taxpayer).

     Extending to all Kersting project petitioners who were part

of the Kersting project test case procedure the benefit of the

Thompson settlement without the need for further trial or

evidentiary hearing is the sanction that the Court of Appeals

deemed appropriate and necessary to restore the confidence of

future litigants who may become involved in test case

proceedings.    The legitimacy of the test case procedure itself is

at stake, and the need to protect the integrity of the judicial

process justifies the imposition of sanctions against respondent

by vacating the stipulated decisions in all cases that were part

of the Kersting tax shelter project after the test case procedure

was employed.

     B.   Lewis v. Commissioner Reconsidered and Superseded

     Reconsideration under Rule 161 is intended to correct

substantial errors of fact or law and allow the introduction of

newly discovered evidence that the moving party could not have

introduced, by the exercise of due diligence, in the prior

proceeding.     Estate of Quick v. Commissioner, 110 T.C. 440, 441

(1998).   This Court has discretion whether to grant a motion for

reconsideration and will not do so unless the moving party shows
                                - 95 -

unusual circumstances or substantial error.     Zapara v.

Commissioner, 126 T.C. 215, 218-219 (2006); Estate of Quick v.

Commissioner, supra at 441.     “Reconsideration is not the

appropriate forum for rehashing previously rejected legal

arguments or tendering new legal theories to reach the end result

desired by the moving party.”     Estate of Quick v. Commissioner,

supra at 441-442.

     In opposing petitioners’ motions to vacate the decisions in

these cases, respondent relies heavily on the reasoning of our

previously filed Memorandum Opinion, Lewis v. Commissioner, T.C.

Memo. 2005-205, denying the Lewises leave to file motions to

vacate the decisions in their cases.

     In Lewis v. Commissioner, supra, we stated that the

directive of the Court of Appeals that terms equivalent to those

of the Thompson settlement be extended to “appellants and all

other taxpayers properly before this Court” by its terms excludes

those who knowingly settled their cases after the predicate facts

of the fraud on the Court had been disclosed.    In Lewis we

commented that the Court of Appeals would have explicitly said so

if it had intended to extend the Thompson settlement to closed

cases.   In Dixon VI, we accepted and adopted the stipulation of

the parties that the phrase “before the Court” includes all open

cases.   Upon reconsideration, we believe that omission by the

Court of Appeals of any reference to closed cases merely reflects

that the Court of Appeals technically had jurisdiction only over
                              - 96 -

test and nontest cases in which appeals had been filed and that

in the ordinary course of proceedings it was only other nontest

cases in which stipulated decisions had not yet been entered that

would be bound by the final outcome of the test cases.   Because

the cases in which stipulated decisions had been filed were

closed, they would not be before the Court of Appeals in any

sense until the Tax Court acted upon any motions for leave that

later might be filed.

     In Lewis (citing Abatti v. Commissioner, 859 F.2d at 117),

we held that the Lewises were not entitled to the benefits of the

Thompson settlement because they did not appeal their cases.      In

Abatti the Court of Appeals held that taxpayers in a tax shelter

group who had signed piggyback agreements and failed to appeal

adverse decisions in the test cases were not entitled to the

relief gained by other piggybackers who did appeal the adverse

decisions.   The Court of Appeals observed that “There is ‘no

general equitable doctrine * * * which countenances an exception

to the finality of a party’s failure to appeal merely because his

rights are “closely interwoven” with those of another party.’”

Id. at 120 (quoting Federated Dept. Stores, Inc. v. Moitie, 452

U.S. 394, 400 (1981)).

     In Abatti, the Court of Appeals specifically held that the

situation in that case was not “sufficiently analogous to ‘fraud

on the court’ to warrant an exception to the rule that the Tax

Court lacks jurisdiction to vacate a final decision.”    Id. at
                                - 97 -

119.    In the cases at hand, the Court of Appeals has held that

there was fraud on the Tax Court in the Kersting test case

proceedings.    Abatti is therefore not on point.

       In Lewis, we analyzed the Lewises’ settlement under general

principles of contract law.    We held that the Lewises were bound

by their settlement and precluded from claiming fraud because,

when they accepted the posttrial settlement offer, they and their

counsel, Jones and O’Donnell, had actual or constructive

knowledge (1) of the predicate facts of the misconduct of

respondent’s attorneys, including the terms of the Thompson

settlement, and (2) that the test cases were being appealed,

inter alia, on the ground that respondent’s misconduct had

created a fraud on the Court.

       In Lewis, we failed to consider that this Court knew that

there had been secret settlements in the Cravens and Thompson

cases when it vacated the decisions that had been entered in

those cases in accordance with Dixon II and yet failed to

recognize that a sanctionable fraud had been committed on the

Court.    The full extent of McWade’s and Sims’s misconduct was not

known until the hearing on remand pursuant to DuFresne.     The

DuFresne panel knew the overall terms of the secret Thompson

settlement.    Yet that same panel, in Adair v. Commissioner, 26

F.3d 129 (9th Cir. 1994), held that the decision entered in the

Thompson cases had become final, which would not have been so had

the panel recognized that the misconduct might have been a fraud
                              - 98 -

on the court.   If knowledge of the existence and terms of the

secret Thompson settlement did not alert this Court or the

DuFresne panel that the misconduct was a fraud on the Court, we

cannot now say that the same knowledge of petitioners and their

counsel now bars this Court from imposing sanctions on respondent

for the fraud committed on the Court in the cases at hand.

     Moreover, our holding in Lewis in effect required the

Lewises to show prejudice and allowed respondent to dispute the

effectiveness of the fraud after the fact.   On reflection and

reconsideration, we now hold that our holding in Lewis is

contrary to the holding in Dixon V that the taxpayers who were

part of the test case proceedings need not show prejudice to

justify relief and that respondent, the perpetrator of the fraud,

should not be allowed to dispute the effectiveness of the fraud

after the fact.   Dixon V at 1043, 1046.

     In Lewis we incorrectly focused on the legal consequences of

the Lewises’ acceptance of respondent’s posttrial settlement

offer and applied general principles of contract law.   The proper

focus is on whether respondent could through the posttrial

disclosure and settlement offer purge from these cases the fraud

committed on the Court and whether those actions otherwise

rectified the harm caused by the fraud on the Court, eliminating

the need for the Court to apply the sanction mandated by the

Court of Appeals in cases in which stipulated decisions were

entered.
                               - 99 -

     In Lewis, we failed to consider fully the implications of

the holding of the Court of Appeals that McWade’s and Sims’s

misconduct violated the rights of all Kersting project

petitioners who were bound by the outcome of the Tax Court

proceeding and the need to remedy those violations.    Respondent’s

lowball nuisance value reinstated project settlement offer was an

attempt to control the fallout or damage to respondent and did

not rectify the violation of the rights of the Kersting project

petitioners who were bound by the results of the test cases.

     Upon reconsideration, we believe that we misapplied the law

of the case as it was expounded and applied by the Court of

Appeals in Dixon V, leading us to the wrong result.

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

     Although respondent reported the secret settlements to the

Court and counsel for the remaining test case petitioners

promptly after discovering McWade’s and Sims’s misconduct, those

disclosures did not purge any of the Kersting project cases of

the fraud committed on the Court.   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).   A

taxpayer who files a fraudulent return, regardless of the

taxpayer’s subsequent voluntary disclosure, remains subject to

criminal prosecution and the civil fraud penalty.     Id.   The fraud

is committed and the offense completed when the original
                              - 100 -

fraudulent return is prepared and filed.   Id.   Where a taxpayer

files a false or fraudulent return but later files a

nonfraudulent amended return, section 6501(c)(1) applies and a

tax may be assessed “at any time”, regardless of whether more

than 3 years have expired since the filing of the amended return.

Id. (citing United States v. Habig, 390 U.S. 222 (1968), and

Plunkett v. Commissioner, 465 F.2d 299, 302-303 (7th Cir. 1972),

affg. T.C. Memo. 1970-274); see also George M. Still, Inc. v.

Commissioner, 19 T.C. 1072, 1077 (1953), affd. 218 F.2d 639 (2d

Cir. 1955).

     In the Kersting test case proceedings, the fraud on the

Court committed by respondent’s attorneys was completed once the

test cases were tried.   Respondent’s subsequent disclosures to

the Court and test case counsel of McWade’s and Sims’s misconduct

did not purge the fraud on the Court in any of the test cases,

including the Thompson and Cravens cases, or any of the nontest

cases bound by the test cases.   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 case.

     Although respondent could not purge the fraud on the Court

once it was committed, we will consider whether respondent’s

posttrial actions mitigated the harm done by the fraud in

deciding whether the sanction mandated by the Court of Appeals in
                               - 101 -

Dixon V should be applied in the cases of Kersting project

petitioners who accepted respondent’s posttrial settlement offer.

     We begin by evaluating respondent’s posttrial obligations to

the Court and to Kersting project test case and nontest case

petitioners.    Because the fraud McWade and Sims committed on the

Court undermined future litigants’ confidence in the test case

procedure, we hope that our clarification of respondent’s

obligations to the Court and to taxpayers who are bound by test

case proceedings will help restore public confidence in the test

case procedure.

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

     The Kersting project nontest case petitioners were bound by

the results of unspecified test cases.     Many, if not most,

Kersting project petitioners signed their piggyback agreements

before the test cases were selected.     As a practical matter,

because piggyback agreements did not identify the test cases,

Kersting project nontest case petitioners would not know the

identity of the test case petitioners until informed by

respondent.43   After the Court filed its Dixon II opinion


      43
      In this opinion we identify respondent’s obligations for
purposes of determining whether respondent’s actions mitigated
the harm caused by the fraud on the Court in the nontest cases
for purposes of fashioning an appropriate sanction. Kersting
project nontest case taxpayers who received and read Kersting’s
“Dear Friend” letters learned the identity of the test case
petitioners. Respondent is not entitled to rely on Kersting to
                                                   (continued...)
                              - 102 -

respondent was obligated first to notify all Kersting project

nontest case petitioners of the terms of the Court’s disposition

of all the test cases in Dixon II in order to prepare decision

documents to be entered in the nontest cases.   Cf. Socony Mobil

Oil Co. v. United States, 153 Ct. Cl. 638, 649, 287 F.2d 910, 915

(1961); Estate of Satin v. Commissioner, T.C. Memo. 1994-435;

Fisher v. Commissioner, T.C. Memo. 1994-434.    Once the results of

the test cases and the Dixon II opinion were questioned because

of the misconduct of respondent’s attorneys, respondent had the

additional obligation to inform the Kersting project petitioners

of those facts.   Cf. Socony Mobil Oil Co. v. United States,

supra; Estate of Satin v. Commissioner, supra; Fisher v.

Commissioner, supra.

     In Socony Mobil Oil Co. v. United States, supra, the

Commissioner and the taxpayer had agreed to the suspension of the

period of limitations for filing a refund claim until the final

decision in a test case.   Thereafter the Commissioner settled the

test case, preventing it from being decided on the merits and

frustrating the purpose of the agreement.   The Court of Claims



     43
      (...continued)
fulfil respondent’s disclosure obligations to the nontest case
petitioners. Moreover, reliance on the Kersting letters to
satisfy respondent’s obligation would present factual issues
requiring a trial. “Enormous amounts of time and judicial
resources have been wasted.” Dixon V at 1047. We will not
require another trial in each previously settled case to
determine whether sanctions should be imposed for the fraud on
the Court.
                               - 103 -

observed that, unless the Government informed the taxpayer of the

settlement, the taxpayer would have had to be most diligent in

watching the District Court’s judgment docket in order to file

its suit in time after the “final decision” of the test case.

Id. at 649, 287 F.2d at 915.   The Court of Claims held open the

period of limitations and held that the taxpayer was entitled to

recover on its refund claim.

     In Estate of Satin v. Commissioner, supra, and Fisher v.

Commissioner, supra, the taxpayers agreed to be bound by the

resolution of tax shelter adjustments, whether by litigation or

settlement, in test cases specifically identified in the

agreements by name and docket number, Provizer v. Commissioner,

docket No. 27141-86, and Miller v. Commissioner, docket Nos.

10382-86 and 10383-86.   The Miller cases settled before trial

with the taxpayers conceding the deficiencies and the

Commissioner conceding the additions to tax.   The Commissioner

did not notify any of the taxpayers who had agreed to be bound by

the Provizer and Miller cases that the Miller cases had been

settled.   The Provizer case subsequently was tried on the merits,

resulting in Provizer v. Commissioner, T.C. Memo. 1992-177, affd.

per curiam without published opinion 996 F.2d 1216 (6th Cir.

1993), sustaining both the Commissioner’s deficiency and

additions to tax determinations.   The Commissioner assessed

taxes, additions to tax, and interest in accordance with Provizer

against the taxpayers in the Estate of Satin and Fisher cases.
                               - 104 -

On receiving the assessments, the taxpayers asked about the

Miller cases.    Learning for the first time that the Miller cases

had settled, the taxpayers filed motions for entry of decision

consistent with the terms of the Miller settlements, which the

Court granted.   In granting the motions, the Court held that the

taxpayers should have been given the opportunity to agree to the

terms offered in the Miller cases.   Because the Commissioner

failed to notify the taxpayers of the Miller settlements before

the Provizer case was resolved, the Court held that the taxpayers

were entitled to entry of decision in their cases in accordance

with the more favorable terms of the Miller settlements.

     Respondent asserts that Estate of Satin and Fisher do not

apply, under our holding in Gridley v. Commissioner, T.C. Memo.

1997-210.   In Gridley, we denied the motions for summary judgment

of the Fleer and Gridley Kersting project petitioners and

distinguished Estate of Satin and Fisher because the agreements

in those cases bound the taxpayers to the resolution of the test

cases “whether by litigation or settlement”, whereas the Fleers’

and the Gridleys’ Kersting project piggyback agreements did not

mention settlement of the test cases.    Respondent asserts that

Estate of Satin and Fisher do not apply in the cases at hand

because petitioners, like the Fleers and the Gridleys, were bound

by their piggyback agreements to the Court’s determination in “an

unspecified ‘TRIED CASE’ group of cases”.   We agree that

petitioners’ piggyback agreements do not mention settlement of
                              - 105 -

the test cases.   The Court of Appeals for the Ninth Circuit,

however, remanded Gridley for further proceedings consistent with

Dixon V.

     In so doing, the Court of Appeals in Dixon V established

entitlement to the Thompson settlement as the “law of the case”

for the Kersting project.   In all cases without piggyback

agreements that were governed by the order to show cause

procedure, Dixon V superseded Dixon II, entitling Kersting

project petitioners in such cases to the benefit of the Thompson

settlement.   In effect Dixon V also superseded or amended the

piggyback agreements to incorporate entitlement to the Thompson

settlement just as if the Kersting piggyback agreements had

incorporated the “or settlement” language of the Satin/Fisher

piggyback agreements.

     Moreover, implicit in an agreement binding a private party

to the results of one or more test cases in a test case

proceeding is the requirement that the Government notify the

other party to the agreement about the results of a test case or

cases controlling the agreement, regardless of whether the

private party is bound by the settlement or litigation of the

test cases, as in Estate of Satin and Fisher, or by the

litigation of the test cases, as in Socony Mobil Oil Co. v.

United States, supra at 649, 287 F.2d at 915-916.   We believe the

rationale of Socony Mobil Oil, Estate of Satin, and Fisher that

requires the Government to notify the other party bound by the
                               - 106 -

results, through settlement or litigation, of a test case is just

as compelling when the other party is bound by the outcome of a

trial of an undifferentiated group of test cases.    The

Commissioner knows the names and docket numbers of the test cases

and participates in the trial of those test cases.    Most

importantly, when the Court files its opinion deciding the issues

tried in the test cases, the Commissioner is served a copy of the

opinion.   By contrast, the Court does not serve a copy of its

test case opinion on nontest case taxpayers who are bound by the

opinion, and those taxpayers must await notification by the

Commissioner.

     Every contract imposes upon the parties thereto an implied

duty of good faith and fair dealing.     San Jose Prod. Credit

Association v. Old Republic Life Ins. Co., 723 F.2d 700, 703 (9th

Cir. 1984); Smith v. Empire Sanitary Dist., 273 P.2d 37, 43 (Cal.

Ct. App. 1954); 3A Corbin on Contracts, sec. 654A, at 86 (1998

Supp.).    Since respondent was obliged to inform Kersting project

nontest case petitioners of the results of the test cases,

respondent’s implied duty of good faith and fair dealing imposed

an obligation on respondent to inform nontest case petitioners

that the results of the test cases were being called into

question and to disclose all material facts concerning the

misconduct known to respondent.   The nontest case petitioners

could not have anticipated that motions to vacate the decisions

would be filed in the test cases.   Unless respondent informed
                                - 107 -

them of the motions, they would have had to be most diligent in

checking each of the test case dockets in order to discover

whether decisions entered in any of the test cases were being

vacated or appealed.     See Socony Mobil Oil Co. v. United States,

supra.     Moreover, respondent had the same disclosure obligations

with respect to all nontest case petitioners who did not sign

piggyback agreement; those Kersting project petitioners were

bound by the results in the test case by reason of the Court’s

order to show cause procedure.44

     Respondent recognized respondent’s obligation to inform the

Court and the other test case petitioners about the secret

settlements.45    Respondent contends that respondent had no



     44
          See supra note 6.
     45
         Respondent avers:

     Even before the investigation uncovered all the
     underlying facts, respondent quickly brought the fact
     of the improper settlement to the attention of the
     court and opposing counsel. On June 9, 1992,
     respondent filed motions to vacate decisions in the
     cases of the test case petitioners who were still under
     the Tax Court’s jurisdiction (Thompson, Cravens and
     Ralph Rina (Rina)). The motions requested an
     evidentiary hearing into the entire matter, stating
     that the “existence of the understanding and the
     failure to divulge same to the Court and the other Test
     Case petitioners prior to the trial raise questions
     which should be addressed by the Court and the parties
     * * *.

By filing the motion to vacate in the Rina case, respondent
notified Izen, counsel for other test case petitioners whose
cases were already on appeal, of the predicate facts of the
misconduct of respondent’s attorneys.
                                - 108 -

obligation to inform Kersting project nontest case petitioners of

the terms or existence of the Thompson settlement.    We disagree.

     In respondent’s motion for entry of decision in the Thompson

cases, respondent acknowledged that McWade, Sims, and DeCastro

“owed a special duty to disclose” the Thompson settlement

agreement to the Court.    Quoting Reager v. Anderson, 371 S.E.2d

619, 630 (W. Va. 1988), respondent further acknowledged that

     “It is critical to the fair conduct of the trial to
     disclose promptly the settlement terms to the court and
     to opposing counsel so that the court can decide
     whether the agreement is valid, and if so, what
     measures should be taken to ensure that the nonsettling
     party(ies) will not be prejudiced.” * * * [Emphasis
     supplied by respondent.]

Respondent noted that “this is particularly important where the

settling party remains in the litigation, testifies with respect

to the issues, and his attorney appears to be an advocate adverse

to the party paying the fees.”

     Respondent asserts that respondent fulfilled respondent’s

obligation to disclose the secret Thompson and Cravens

settlements when respondent disclosed the terms of the agreements

to the Court and counsel for the remaining test case petitioners.

To the contrary, that disclosure only satisfied part of

respondent’s obligation.     Reager v. Anderson, supra, concerned

the plaintiff’s “Mary Carter” contingent settlement with one of

the defendant tortfeasors.    The excerpt from Reager v. Anderson,

supra at 630, makes clear that not only the existence of the

settlement agreement with one defendant but also the terms of the
                                - 109 -

agreement must be disclosed to opposing counsel for other

defendants to protect the rights of the nonsettling parties.     In

a test case proceeding, the nonsettling parties include all

taxpayers who are bound by the test case and who may be

prejudiced by the settlement.    Thus, under the reasoning of

Reager v. Anderson, supra, respondent had a further obligation to

disclose the terms of the secret Thompson settlement not only to

the remaining test case petitioners but to all Kersting project

nontest case petitioners who were bound by the outcome of the

test cases.   In cases where the nontest case petitioner was

represented by counsel, respondent was obligated to inform that

counsel of the existence and the terms of the previously

undisclosed Thompson and Cravens settlements.    Where the nontest

case petitioner was proceeding pro se, respondent was obligated

to inform the petitioner of the existence and terms of the

agreements.

     Respondent did not satisfy those obligations.    Although

respondent’s posttrial settlement offer informed the Kersting

project nontest case petitioners that there had been secret

settlements with some test case petitioners, the offer did not

disclose the names of the test case petitioners who had settled

their cases, nor did it disclose the terms of the settlements.

     Finally, when respondent disclosed the secret settlements to

the Court, respondent admitted that McWade and Sims had authority

to enter into the original 18.8-percent Thompson settlement but
                               - 110 -

argued that they did not have authority to enter into the final

Thompson settlement.   Respondent’s position in the motions to

vacate the decisions in the Thompson, Cravens, and Rina cases was

that the Court needed to decide whether the secret settlements

and the testimony of Cravens and Thompson affected the outcome of

the test cases.   Respondent did not disclose to the Court that

McWade’s and Sims’s entering into a secret settlement giving the

Thompsons preferential treatment violated Department of the

Treasury Minimum Standards of Conduct and thus did not alert the

Court that it might be unfair to enter decisions in accordance

with Dixon II in the cases of other Kersting project petitioners.

After the Court denied the motion to vacate the Rina decision,

respondent did not inform the Court when respondent’s National

Office decided “in fairness” to reinstate the lowball nuisance

value project settlement offer, that stipulated decisions were

being entered in Kersting project cases in accordance with that

offer, or that respondent was administratively adjusting Kersting

project petitioners’ tax liabilities that had been assessed in

accordance with Dixon II.   We now agree with the Court of Appeals

for the Ninth Circuit that respondent’s disclosure to the Court

“was anything but complete”.   Dixon V at 1045 n.8.

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

     We next consider whether respondent’s posttrial actions

rectified or otherwise mitigated the harm done by the fraud in
                                - 111 -

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.

In so doing, we recognize that the Court of Appeals was aware

when it fashioned the sanction it deemed appropriate that

respondent had promptly disclosed the overall misconduct to this

Court after discovering the secret agreements.

     A party cannot avoid sanctions for committing a fraud on the

court by settlement or withdrawal from the case.   See, e.g.,

Bader v. Itel Corp. (In re Itel Secs. Litig.), 791 F.2d 672 (9th

Cir. 1986).   It is well settled that an agreement between private

parties cannot deprive the Court of its power to investigate, to

render rulings, or to impose sanctions for an alleged fraud upon

the court.    Chambers v. NASCO, Inc., 501 at 44 (citing Universal

Oil Prods. Co. v. Root Ref. Co., 328 U.S. 575, 580 (1946)); see

also Hazel-Atlas Glass Co. v. Hartford-Empire Co., 322 U.S. 238

(1944); Bush Ranch, Inc. v. E.I. du Pont de Nemours & Co., 918 F.

Supp. 1524 (M.D. Ga. 1995), revd. and remanded on other grounds

99 F.3d 363 (11th Cir. 1996).    “Of particular relevance here, the

inherent power also allows a federal court to vacate its own

judgment upon proof that a fraud has been perpetrated upon the

court.”   Chambers v. NASCO, Inc., supra at 44 (citing Hazel-Atlas

Glass Co. v. Hartford-Empire Co., supra, and Universal Oil Prods.

Co. v. Root Ref. Co., supra at 580); see also Cooter & Gell v.

Hartmarx Corp., 496 U.S. 384, 396 (1990) (“A court may make an
                              - 112 -

adjudication of contempt and impose a contempt sanction even

after the action in which the contempt arose has been

terminated.”); Bush Ranch, Inc. v. E.I. DuPont De Nemours & Co.,

99 F.3d at 367-368 (District Court had power to investigate an

alleged fraud upon the court and impose civil sanctions for the

fraud in a case where the plaintiffs had voluntarily moved for

dismissal of their claims with prejudice 2 years earlier).

     Further, we agree with petitioners that their acceptance of

the posttrial settlement offer did not release respondent from

the consequences of the fraud on the Court.   In Lewis v.

Commissioner, T.C. Memo. 2005-205, we stated that the Lewises

settled their cases with the understanding, set forth explicitly

in respondent’s posttrial settlement offer, that accepting the

offer would “‘preclude any further challenge or appeal with

respect to the Kersting programs or the merits of the Dixon

opinion’.”   On reconsideration, we now conclude that petitioners’

requests that sanctions be imposed on respondent for the fraud

committed in their cases is not a challenge to the Kersting

programs or to the merits of the Dixon II opinion within the

meaning of respondent’s posttrial settlement offer.

     A settlement “is a contract and thus is a proper subject of

judicial interpretation as to its meaning, in light of the

language used and the circumstances surrounding its execution.”

Robbins Tire & Rubber Co. v. Commissioner, 52 T.C. 420, 435-436

(1969); see also Brink v. Commissioner, 39 T.C. 602, 606 (1962),
                               - 113 -

affd. 328 F.2d 622 (6th Cir. 1964); Saigh v. Commissioner, 26

T.C. at 177; Davis v. Commissioner, 46 B.T.A. 663, 671 (1942);

Himmelwright v. Commissioner, T.C. Memo. 1988-114.      The

circumstances in the Kersting test case proceedings and the terms

of the posttrial settlement offer show that petitioners did not

release respondent from claims arising from or related to

McWade’s and Sims’s misconduct during the Kersting test case

proceedings.

     First, respondent’s lowball posttrial settlement offer

omitted material facts that might have affected some petitioner’s

decisions to settle their cases, and those omissions were

deliberate.    Respondent asserts that the highest levels of

respondent’s management reviewed the posttrial settlement offer

and provided input into the final product and that there was no

effort to mislead or conceal facts.      Although respondent’s

highest management did participate in the process, we disagree

that there was no effort to mislead or conceal facts.

     The Dombrowski draft, which was the earliest and most

forthcoming of the drafts, did not reveal the terms of the secret

settlements, and the later drafts, culminating in the posttrial

settlement offer, progressively revealed fewer and fewer material

facts.   The Dombrowski draft revealed that before the trial

settlement agreements had been reached with two of the test case

petitioners and identified the Cravenses and the Thompsons as

those petitioners.   It gave a full citation for Dixon II,
                                - 114 -

explained the holding of the case, and informed the reader that

five of the test case petitioners (Dixon, DuFresne, Hongsermeier,

Owens, and Young) had appealed their cases to the Court of

Appeals for the Ninth Circuit, but that the appeals had not yet

been resolved.

     Each subsequent draft included less and less information.

Respondent’s final posttrial settlement offer informed the

offerees of the Court’s holding and gave a citation to Dixon II.

It informed the reader that two test case petitioners had entered

into settlement agreements before the trial, and that these

agreements had not been disclosed to the Tax Court or the other

test case petitioners.

     Respondent’s posttrial settlement offer constituted less

than full disclosure and was misleading in a number of respects.

It did not identify the test case petitioners who had settled

their cases, did not identify the other test case petitioners,

and did not describe the terms of the settlements.   It did not

even indicate that the two couples who had settled their test

cases had received very different settlements and that one couple

had received a settlement that was much more favorable to them

than all but one other settlement (the Alexander settlement) with

Kersting project petitioners.    It did not disclose the amounts or

percentages of the reductions of the deficiencies in the Cravens

and Thompson settlements and the disparity between them.   It did

not disclose that the Thompson settlement was not only initially
                                - 115 -

more favorable to the Thompsons than the project settlement offer

(and that there had been other settlements more advantageous to

Kersting project petitioners than the project settlement offer),

but that the more favorable Thompson settlement was finally

substantially sweetened to create a fund to pay the fees of

DeCastro, Thompson’s counsel.    The offer’s purported

reinstatement of the project settlement offer did not refer to

the burnout that McWade had incorporated in the project

settlement offer and in the settlements of a majority of the

cases that had been settled before the termination of

respondent’s original project settlement offer.    Most of these

facts had been disclosed to the Tax Court in summer 1992 in

respondent’s papers opposing Thompson’s counsel’s motion to enter

decision on the terms of the Thompson settlement, but they were

not disclosed by respondent to the offerees.

     The offer’s statement that “The Tax Court’s opinion as it

pertains to other Kersting cases remains unchanged” was

misleading, because it conveyed the impression that Dixon II and

the Court’s rulings were the last word on the subject.    It failed

to disclose that the other test cases were on appeal and that

appellants were asserting fraud on the court as a ground for

vacating the decisions in the other test cases.

     The failure of the offer to disclose and identify the test

case petitioners who had received a very different settlement,

giving them much more favorable treatment, and that giving
                              - 116 -

preferential treatment violated IRS policy and the Department of

the Treasury Minimum Standards of Conduct renders disingenuous

the statement in the posttrial settlement offer “we have

concluded that in fairness all petitioners be afforded an

opportunity to settle their cases”.

     The lack of fairness of the 7-percent offer is further

evidenced by the disciplinary action respondent brought against

McWade and Sims solely on the basis of the Thompson settlement

and not the secret Cravens settlement, which approximated the 7-

percent project settlement offer.    The notices of proposed

disciplinary action sent to McWade and Sims on July 29, 1993,

asserted, inter alia, that they had (1) failed to avoid any

action which might result in or create the appearance of giving

preferential treatment to any person; (2) failed to avoid any

action that might adversely affect the confidence of the public

in the integrity of the Government; and (3) intentionally made

false or misleading verbal or written statements in matters of

official interest.   The notices listed the following reasons for

the proposed disciplinary actions:    (1) Negotiating an

unauthorized settlement agreement with the Thompsons; (2) basing

the Thompson settlement on unaudited and insufficiently

documented losses from an unrelated shelter; (3) allowing the

Thompsons a settlement that provided them more favorable

treatment than other taxpayers; (4) compensating the Thompsons

for their attorney’s fees; and (5) not informing the Tax Court of
                             - 117 -

the Thompson settlement arrangements.   The notices make no

mention of the Cravens settlement even though that settlement

also had not been disclosed to the Court.    The notices clearly

focus on the favorable treatment and benefits given to the

Thompsons.

     Under normal circumstances, the Commissioner is not required

to offer the same settlement terms to taxpayers whose cases are

part of a test case proceeding.   See Estate of Campion v.

Commissioner, 110 T.C. 165, 170 (1998), affd. without published

opinion sub nom. Tucek v. Commissioner, 198 F.3d 259 (10th Cir.

1999), affd. without published opinion sub nom. Drake Oil Tech.

Partners v. Commissioner, 211 F.3d 1277 (10th Cir. 2000).

However, under the circumstances in the Kersting test case

proceedings and consistent with the Department of the Treasury

Minimum Standards of Conduct, we believe “in fairness” that

respondent should have offered to provide other Kersting

taxpayers the same favorable treatment given to the Thompsons, as

the Court of Appeals finally concluded in Dixon V.

     In Estate of Campion, the taxpayers had settled all issues

related to their participation in certain tax shelters, and final

decisions had been entered in their cases.   The underlying tax

shelters were the subject of test case litigation in Krause v.

Commissioner, 99 T.C. 132 (1992), affd. sub nom. Hildebrand v.

Commissioner, 28 F.3d 1024 (10th Cir. 1994); Acierno v.

Commissioner, T.C. Memo. 1997-441, affd. without published
                              - 118 -

opinion 185 F.3d 861 (3d Cir. 1999); Karlsson v. Commissioner,

T.C. Memo. 1997-432; and Vanderschraaf v. Commissioner, T.C.

Memo. 1997-306, affd. without published opinion 211 F.3d 1276

(9th Cir. 2000), affd. without published opinion sub nom. Estate

of Lawrenz v. Commissioner, 238 F.3d    429 (9th Cir. 2000).

Beginning in 1986, the Commissioner made a series of settlement

offers to the tax shelter investors.    As time went by and the

test cases approached trial, the Commissioner’s settlement

position generally became more favorable to the Commissioner and

less favorable to the investor-taxpayers.    Each of the various

settlement offers incorporated a time deadline beyond which the

settlement would no longer be available.

     The Estate of Campion taxpayers did not choose to settle

their cases.   Rather, they waited until after the issuance in

1992 of the opinion in the test cases in Krause v. Commissioner,

supra.   The settlements the Estate of Campion taxpayers then

agreed to were consistent with the decisions in Krause and the

related cases.   The Estate of Campion taxpayers thereafter sought

orders from the Court vacating their agreed decisions and

requiring the Commissioner to give them new settlements

incorporating the more favorable settlement terms that had been

available to taxpayers in earlier years.    In so doing, the Estate

of Campion taxpayers alleged, inter alia, that there had been a

fraud on the Court in the settlement of their cases.
                             - 119 -

     In Estate of Campion, we held that the Commissioner had not

committed fraud on the Court and denied the taxpayers leave to

file motions to vacate final decisions.   In deciding that the

Commissioner had not committed fraud on the Court, we noted that

the taxpayers’ former and/or then-present counsel, who

represented many taxpayers who were involved in the tax shelters,

had been aware of all settlement positions that had been made

available by the Commissioner.   We emphasized that all investors

in the tax shelters were treated consistently by the Commissioner

and were given the same opportunity to settle their tax disputes

on the same terms and with the same time deadlines, and that each

different settlement position of the Commissioner had been

adequately communicated to all investors in the tax shelters and

had been based on the “hazards of litigation” as perceived by the

Commissioner at each relevant point in time.   The taxpayers

thereby failed to establish any “scheme of secrecy” to hide the

availability of the Commissioner’s various settlement positions,

which had been made available over the years to all taxpayers who

had invested in the tax shelters.

     None of the exculpating factors considered by the Court in

Estate of Campion are present in the cases at hand.    The record

is replete with aggravating factors to the contrary.   Respondent

did not treat all Kersting project petitioners consistently;

respondent did not give all Kersting project petitioners the same
                                - 120 -

opportunity to settle their tax disputes on the same terms and

with the same time deadlines.    Only the initial 7-percent project

settlement offer and the modified 7-percent settlement offer with

the burnout had been adequately communicated to all Kersting

project petitioners.   The 20-percent settlements negotiated by

DeCastro and by Chicoine and Hallett for some of their clients

and the various Thompson settlements were not communicated to

other Kersting project petitioners.       Only the 20-percent

settlements had been based on the “hazards of litigation”.      The

final Thompson settlement was not communicated to any other

Kersting project petitioners and was not based on the hazards of

litigation, and most importantly, there was a “scheme of secrecy”

to hide the Thompson settlement that constituted the fraud on the

Court.

     Respondent acknowledged that McWade and Sims had authority

to negotiate the 20-percent settlements and that the Thompsons

were entitled to have decisions entered in accordance with their

initial settlement agreement.    Once McWade and Sims began to

accept 20-percent settlements on the basis of hazards of

litigation, they should have communicated a 20-percent offer to

all Kersting project petitioners so as not to favor those

petitioners represented by DeCastro and Chicoine and Hallett over

others, especially those who were unrepresented by counsel.

Their failure to do so undermined the confidence of the Court and
                              - 121 -

the public in the fairness of the test case procedure.    The

factors we considered in Estate of Campion lead us to conclude

that, once respondent discovered McWade’s and Sims’s misconduct

and decided that “in fairness” the other Kersting project

petitioners ought to have the opportunity to settle on more

favorable terms than provided by Dixon II, in fairness respondent

should have made the 20-percent initial Thompson settlement

available to the other Kersting project petitioners.     Such an

offer would have been consistent with respondent’s position in

respondent’s motions for entry of decision in the Thompson cases

that the 20-percent settlements were valid, but that the final

Thompson agreement was invalid because respondent’s provision for

payment of DeCastro’s fees was illegal.46

     Respondent’s management owed every petitioner whose case was

bound by the Kersting project test case proceedings a duty of good

faith and fair dealing.   “Chief Counsel attorneys are expected to

adhere to the highest standards of conduct, not simply conform to



      46
       During the Dixon V remand proceeding, respondent also
 contended that the final Thompson settlement represented a
 20-percent reduction in Kersting deficiencies, plus legal fees
 incurred in trying the test cases. In Dixon VI, we rejected
 respondent’s argument that Kersting project petitioners were not
 entitled to recover legal fees after Dixon II because the fees
 had been paid by Kersting and therefore petitioners were entitled
 only to the 20-percent reduction in liabilities. We instead gave
 effect to the Thompson settlement in accordance with its express
 terms, as a more than 60-percent reduction in the Kersting
 deficiencies.
                              - 122 -

minimum professional obligations.”   CC-2003-008 (appendix B).    The

“goal as IRS lawyers cannot be to collect the most revenue for the

government or win cases at all costs.   * * * [The] goal must be to

ensure that the tax system is administered fairly and

impartially”.   Williams, Remarks at the Meeting of the New York

State Bar Association Tax Section (Jan. 21, 2003) (appendix A).

In offering the posttrial settlement, respondent’s management fell

short of that goal and failed to satisfy the duty of good faith.

     We have held that McWade and Sims committed a fraud on the

Court in every case that was bound by the Kersting project test

cases and that the fraud was not purged by respondent’s disclosure

to the Court.   Additionally, we have found (1) that respondent was

obligated to inform Kersting project nontest 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.

Willful concealment or omission of material facts or intentional

statements of half-truths will support a finding of fraud.    United

States v. Romano, 736 F.2d 1432, 1439 (11th Cir. 1984), revd. in

part on other grounds 755 F.2d 1401 (11th Cir. 1985).   Misleading

half-truths are distinguishable from nondisclosures and constitute

an exception to the general rule of nonliability for nondisclosure

or other failure to act.   Randi W. v. Muroc Joint Unified Schl.

Dist., 929 P.2d 582, 592 (Cal. 1997).   Providing “‘half of the
                               - 123 -

truth may obviously amount to a lie, if it is understood to be the

whole.’”   Id. at 592 (quoting Prosser & Keeton, The Law of Torts,

Misrepresentation and Nondisclosure, sec. 106, at 738 (5th ed.

1984)).    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 disclosed.   See id. at 1082.   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.

Saigh v. Commissioner, 26 T.C. at 180; Fisher v. Commissioner,

T.C. Memo. 1994-434.

     Respondent’s limited disclosure and reinstatement of the

lowball nuisance value pretrial settlement offer could not “purge”

the fraud on the Court that attached to the cases of the Kersting

project nontest case petitioners and did not mitigate the harm

caused by the misconduct.   Respondent’s failure to disclose fully

all material facts in the posttrial settlement offer and the

express language of the posttrial settlement offer show that the

acceptance of the posttrial settlement offer did not release

respondent from Kersting project petitioners’ claims of fraud on

the Court or bar them from requesting that the Court impose

sanctions for the violation of petitioners’ rights.   The language

in the stipulated decisions and the posttrial settlement agreement

does not contain language specifically releasing respondent from
                              - 124 -

matters arising from the misconduct.    See U.S. Anchor

Manufacturing, Inc. v. Rule Indus., Inc., 27 F.3d 521 (11th Cir.

1994); see also U.S. Anchor Manufacturing, Inc. v. Rule Indus.,

Inc., 7 F.3d 986, 1004 (11th Cir. 1993).

     An agreement that settles only specific matters does not

necessarily settle other matters related to the settled ones.

Manko v. Commissioner, 126 T.C. 195, 204 (2006).    In Manko, the

parties agreed to the treatment of the partnership items in the

closing agreement.   The preamble to the closing agreement

explained that the parties wished to determine with finality the

taxpayers’ distributive share of income, gains, losses,

deductions, and credits with respect to the partnership for the

years at issue.   The final paragraph of the closing agreement

provided that the agreement did not affect or preclude later

adjustments of any item (other than those relating to the

partnership) for the years at issue.    The Commissioner sent the

taxpayers Income Tax Examination Changes that reflected the

Commissioner’s computation of their tax liabilities in accordance

with the agreed treatment of the partnership items.   The

Commissioner then assessed the deficiencies shown in the Income

Tax Examination Changes without issuing the taxpayers a notice of

deficiency.   The Commissioner never issued the taxpayers a

deficiency notice for the years at issue, and the taxpayers never

executed a formal waiver of restrictions on assessment.     The Court
                               - 125 -

held that the closing agreement covered the specific partnership

items only and did not absolve the Commissioner from issuing a

deficiency notice before assessing the taxpayers’ liabilities.

     In the cases at hand the posttrial settlement offer 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.”    We have repeatedly found that

the fraud on the Court did not affect the Dixon II opinion as it

related to the merits of the case or the validity of the Kersting

programs.   The harm caused by the fraud on the Court, namely the

violations of the rights of the Kersting project petitioners, is

unrelated to the Kersting programs or the merits of the Dixon

opinion.    Whether respondent should be sanctioned for the fraud on

the Court as it relates to petitioners’ cases is not a “challenge

or appeal with respect to the Kersting programs or the merits of

the Dixon opinion”.   Rather, it is a claim for a remedy and a

sanction for the violation of petitioners’ rights that is another

issue involved in the Kersting project cases, the resolution of

which respondent’s language specifically excluded from the

posttrial settlement being offered.      The posttrial settlement

agreement has no provision “releasing” respondent from claims

related to the misconduct of respondent’s attorneys during the

trial of the test cases.
                              - 126 -

     Although respondent may have intended the phrase “other

issues involved in this case will be resolved separately” to refer

to non-Kersting issues related to adjustments made in the notices

of deficiency issued to Kersting project petitioners, the general

contract principle of contra proferentem weighs heavily against

respondent.   That principle requires that an ambiguous provision

in a written document be construed more strongly against the

person who selected the language.   United States v. Seckinger, 397

U.S. 203, 216 (1970); Moulor v. Am. Life Ins. Co., 111 U.S. 335,

341-342 (1884) (citing Grace v. Am. Cent. Ins. Co., 109, 282 U.S.

278 (1883)); Kunin v. Benefit Trust Life Ins. Co., 910 F.2d 534,

539 (9th Cir. 1990); Rink v. Commissioner, 100 T.C. 319, 328 n.8

(1993), affd. 47 F.3d 168 (6th Cir. 1995).

     Moreover, it is the Court that holds the inherent power to

impose sanctions against respondent for the fraud committed on it,

and the parties cannot by agreement divest the Court of that

power.   Neither the terms of the settlements nor the stipulated

decisions entered in these cases release respondent from any

claims by petitioners that the Court should impose sanctions for

the fraud committed on the Court in their cases.

     After reviewing respondent’s posttrial actions and settlement

offer in their totality, we conclude that those actions and the

posttrial settlement offer did not rectify respondent’s violation

of the rights of Kersting participant petitioners who were bound
                               - 127 -

by the results of the test cases; in fairness, all Kersting

project petitioners whose cases were bound by the Kersting test

case proceedings are entitled to the benefit of the Thompson

settlement.

                              Conclusion

     We hold that neither the posttrial settlement offer nor the

stipulated decisions thereby generated bar the Court from

considering the fraud on the Court as it affected all cases

pending at the time the offer was made or imposing sanctions to

remedy the harm caused by the fraud on the Court.   We also hold

that all Kersting project petitioners whose cases were bound by

the results in the Kersting project test cases are entitled to the

benefit of the Thompson settlement regardless of when they settled

their cases.   All taxpayers whose cases are part of a test case

procedure should be assured that the test cases will be well and

fairly tried, regardless of whether or when they settle their

cases.   The misconduct that was a fraud on the Court began long

before the trial of the test cases that resulted in Dixon II.   The

Kersting project test case proceedings began June 10, 1985, the

first day of the June 1985 session during which the Court agreed

with Seery and McWade to use the test case proceeding to resolve

all Kersting project cases.   We do not think that justice would be

served if we were to require another trial in each previously

settled case to determine whether sanctions should be imposed for
                              - 128 -

the fraud committed on the Court during the Kersting test case

proceedings.   As expressed by the Court of Appeals in Dixon V at

1047:

          Here, it plainly would be unjust to remand for a
     new, third trial. The IRS had an opportunity to present
     its case fairly and properly. Instead its lawyers
     intentionally defrauded the Tax Court. The Tax Court
     had two opportunities to equitably resolve this
     situation and failed. Enormous amounts of time and
     judicial resources have been wasted. * * *

     In Hazel-Atlas Glass Co. v. Hartford Empire Co., 322 U.S. 238

(1944), the Supreme Court explained that the inquiry into whether

a judgment should be set aside for fraud on the court focuses not

so much on whether the alleged fraud prejudiced the opposing party

but on whether the alleged fraud harms the integrity of the

judicial process.   The misconduct of McWade and Sims was a fraud

on the Court because it harmed the integrity of the judicial

process.   The judicial process that was harmed by the misconduct

was more than just the trial of the test cases; the judicial

process that was implicated is the test case procedure that

encompassed the cases of all taxpayers before this Court that were

bound by the results in the test cases.   The judicial process

referred to by the Court of Appeals also encompasses all future

cases employing test case procedures.   Taxpayers’ confidence in

future test case proceedings was undermined by the misconduct.

Dixon V at 1046-1047.   In deciding the proper sanction to impose

for the fraud on the Court, we must “carefully balance the policy
                               - 129 -

favoring adjudication on the merits with * * * the need to

maintain institutional integrity and the desirability of deterring

future misconduct.”    Aoude v. Mobil Oil Corp., 892 F.2d 1115, 1118

(1st Cir. 1989) (finding that the District Court considered the

relevant factors and in dismissing the action acted well within

its discretion).

     Respondent’s attorneys committed a fraud on the Tax Court

during the Kersting test case proceedings that was a fraud on the

Court in every case bound by the results of the test cases.

Extending to every petitioner whose case was bound by the results

of the Kersting project test cases, by piggyback agreement or the

Court’s order to show cause procedure, the benefit of the Thompson

settlement strikes us as an appropriate accommodation of the

competing considerations; it is a sanction for the misconduct that

is consistent with Dixon V and is “no more than necessary” to

maintain public trust in the judicial process that employs test

case procedures.    See, e.g., Gomez v. Vernon, 255 F.3d 1118, 1135

(9th Cir. 2001).    We have considered the relevant factors with the

standard set by the Court of Appeals in Dixon V.     We are

protective of the integrity of our judicial process and concerned

about deterrence.   We are “entitled to send a message, loud and

clear.”   Aoude v. Mobil Oil Corp., supra at 1122.    We hold that

sanctions should be imposed in the cases of all Kersting project

petitioners in which stipulated decisions were entered on or after
                               - 130 -

June 10, 1985, the date the Kersting project test case proceedings

began.

     Our holding is limited to the unique and narrow circumstances

of these cases--where we are imposing sanctions for a fraud

committed on the Court in a test case proceeding that bound more

than a thousand cases.   Compare Dixon V with Abatti v.

Commissioner, 859 F.2d at 117.

     Having reconsidered Lewis v. Commissioner, T.C. Memo. 2005-

205, and addressed the merits of petitioners’ arguments and

respondent’s objections, we shall grant petitioners’ motions to

vacate the stipulated decisions entered in the cases at hand and

enter new decisions in accordance with Dixon VI and Dixon VIII,

giving effect to the opinion of the Court of Appeals for the Ninth

Circuit in Dixon V.

                      Implementation of Sanction

     Recognizing that “Enormous amounts of time and judicial

resources have been wasted”, the Court wishes to relieve other

Kersting project nontest 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.   We believe that the most expeditious and efficient

means of implementing the sanction is to allow respondent to

adjust administratively the accounts of all Kersting project

petitioners, other than Hartman, the Lewises, and the Lius,
                               - 131 -

without requiring further action from the Kersting project

petitioners.47   Administrative adjustments would eliminate the need

for other Kersting project petitioners to file motions for leave

to file motions to vacate the decisions in their cases and the

attorney’s fees that otherwise might be incurred and claimed for

the preparation and filing of such motions.

     To facilitate the implementation of this sanction, we shall

issue an order (the implementation order) directing respondent to

send a copy of this opinion and the implementation order to all

taxpayers who filed petitions in this Court contesting the

adjustments at issue in Dixon II who had stipulated decisions

entered in their cases (closed cases) on or after June 10, 1985.

That notification action by respondent is 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.

See Bush Ranch, Inc. v. E.I. du Pont de Nemours & Co., 918 F.

Supp. at 1556.

     Respondent shall have 9 months after the date the decisions

in these cases becomes final (the implementation period) to adjust


      47
       It appears to the Court that respondent can make such
 administrative adjustments as evidenced by the fact that, after
 the decisions in the Kahle cases became final, respondent
 administratively partially abated Kahle’s agreed deficiency by
 giving him the benefit of the 7-percent reduction provided for in
 the posttrial settlement offer.
                              - 132 -

administratively the accounts of all Kersting project petitioners

who had stipulated decisions entered in their cases on or after

June 10, 1985.   The implementation order will require respondent

to provide the following additional information to the Kersting

project petitioners:

     1.   The name of IRS contact personnel who can answer any

questions Kersting project petitioners may have concerning the

adjustments of their accounts;

     2.   the date the decisions in these cases became final; and

     3.   the expiration date of the implementation period.

The implementation order will require respondent, on or before the

expiration of the implementation period, to file a status report

with the Court, listing the cases of all Kersting project

petitioners to whom respondent sent copies of this opinion and the

implementation order and identifying any petitioner whose account

has not been adjusted administratively.

     During the implementation period, the Court will not grant

leave to file motion to vacate decision in any case where motions

for leave have been filed.   If respondent adjusts administratively

the accounts of those Kersting project petitioners who have filed

motions for leave and the parties notify the Court of the

adjustment, the Court will deny as moot the motions for leave.

Additionally, the Court will not accept for filing any motions for

leave to file motions to vacate the decisions in the cases of any
                              - 133 -

other Kersting project petitioner unless and until respondent

fails to adjust administratively the account of the Kersting

project petitioner before the expiration of the implementation

period.   If respondent does not timely adjust administratively the

account of any Kersting project petitioner, the Court will accept

for filing a motion for leave to file motion to vacate decision,

will grant leave to file such a motion, and will order respondent

to show cause why the Court should not grant the motion to vacate

decision and enter a new decision in accordance with this opinion.

     To reflect the foregoing,


                                        Appropriate orders will be

                                 issued, and decisions will be

                                 entered under Rule 155.
                             - 134 -

                            APPENDIX A

  B. John Williams, Jr., Chief Counsel, Internal Revenue Service
   Remarks at the Meeting of the New York State Bar Association
          Tax Section (Jan. 21, 2003), in 2003 TNT 15-20



     The public’s confidence in our tax system rests, in
significant part, on their perception of fairness in the
administration of the tax laws. This begins with government first.
We need to be open with the public on our positions, principled in
our application of the laws, and even-handed in our enforcement
efforts. In this connection, I would like to comment on a case
that you may have read about in Sunday’s New York Times. The 9th
Circuit on Friday handed down an opinion justifiably excoriating
the Chief Counsel’s Office for the conduct of two lawyers who
committed fraud on the Tax Court. The incident occurred a number
of years ago, but the lessons to be learned are fresh. A lead
test case was chosen to resolve a tax shelter in the Tax Court.
About 1300 taxpayers signed piggyback agreements to be bound by
the outcome of the test case. The IRS lawyers agreed to a secret
settlement with the taxpayer in the lead case that remained
undisclosed and unavailable to anyone else. Then, the settling
taxpayer testified that there had been an understanding that the
documents underlying the shelter were not to be enforced. The
settlement came to light after the Tax Court sustained the entire
deficiency and the negligence penalty because the decision
documents did not reflect the Court’s opinion. The Dixon case
presented the issue of what remedy was appropriate to rectify the
effects of the fraud. The Tax Court refused to hold an
evidentiary hearing on the taxpayers’ allegations, and the Ninth
Circuit reversed. After holding the mandated hearing, the Tax
Court found that fraud on the court had been committed but that it
was harmless error. The recent reversal makes clear that fraud on
the court is never harmless; the Ninth Circuit decided that the
appropriate remedy was to give to all of the affected taxpayers
the same settlement that the IRS lawyers had granted to the lead
test case. I want you to know that I fully concur with both the
Ninth Circuit’s outrage over the fraud and its mandate. Is there
any taxpayer who could believe that he or she would receive a fair
trial of their cause if IRS lawyers could secretly offer a deal in
the lead test case and then offer tainted testimony to convince a
court that the transaction at issue was unsound? Fraud on any
court is, in my view, not only pernicious to the fair resolution
of the particular case, but also threatening to fundamental
democratic principles. As an institution, the Office of Chief
                             - 135 -

Counsel must adhere to the highest standards of conduct not simply
conform to minimum professional obligations. In connection with
implementing the Ninth Circuit’s mandate, I have instructed our
attorneys to do the following:

      1. We will expeditiously implement the Ninth Circuit’s
     mandate to extend to all affected taxpayers the terms of
     the settlement that were effected in the lead test case.
     We will also assure that no interest is charged on
     deficiencies for the period of the appeals to the Ninth
     Circuit.

     2. I am circulating a copy of the Ninth Circuit’s
     opinion to all of my lawyers with a cover memo
     reiterating the duties that we have as officers of the
     court and as lawyers for the Commissioner. We must
     admit the pernicious nature of this conduct and not
     permit it or anything like it to be repeated. There can
     be no harmless error resulting from fraud on the court.

     3. I will correspond with the Ninth Circuit to
     apologize for the conduct and indicate what steps I will
     take to avoid such conduct in the future, including
     specific professional education efforts.

               *    *    *    *    *    *    *

     * * * I want to reiterate that I expect and demand that Chief
Counsel lawyers live up to the highest professional standards and
engage in best practices. Our goal as IRS lawyers cannot be to
collect the most revenue for the government or win cases at all
costs. Our goal must be to ensure that the tax system is
administered fairly and impartially and that we reach the right
result for the taxpayers and the government.

     Although some would like to deny that the tax system plays a
vital role in society, and few of us actually like paying taxes,
confidence in the integrity and fairness of the tax system is
vital to our democracy. The tax system touches more people in
this country than any other part of the government or our laws.
The loss of confidence in its integrity is the loss of confidence
in the government itself. * * *
                                - 136 -

                               APPENDIX B


             Excerpts from Chief Counsel Notice CC-2003-008
               Deborah A. Butler, Associate Chief Counsel
                     (Procedure and Administration)

Purpose

     This notice reminds all Chief Counsel attorneys of their
obligation to adhere to the highest ethical standards in all
aspects of their responsibilities, including representation of the
Commissioner before the Tax Court.

Discussion

     The Chief Counsel is the chief law officer for the Internal
Revenue Service. As such, the Chief Counsel is empowered to
represent the Commissioner in cases before the Tax Court, and to
determine which civil actions should be litigated under the laws
relating to the Internal Revenue Service, including making
recommendations to the Department of Justice regarding those
actions. I.R.C. § 7803(b)(2). In carrying out these duties, Chief
Counsel attorneys must be mindful that they are acting on behalf
of the Chief Counsel, not in their individual capacity, and that
their actions reflect on the entire Office of Chief Counsel, the
Service and the Treasury Department. See CCDM 35.8.12.14.
Accordingly, Chief Counsel attorneys are expected to adhere to the
highest standards of conduct, not simply conform to minimum
professional obligations.

     To help put this principle into practice, Chief Counsel
attorneys are reminded that, in representing the Commissioner,
they must conduct their activities in accordance with the letter
and spirit of the Model Rules of Professional Conduct of the
American Bar Association. * * * Our role as Chief Counsel
attorneys is to ensure the uniform application of the tax laws and
the fair disposition of cases.

                 *    *    *    *    *      *   *

     As officers of the court, we have a    special duty to avoid
conduct that undermines the integrity of    the adjudicative process.
We should not allow a court to be misled    by false statements of
law or fact, or evidence that the lawyer    knows to be false. We
must ensure that our actions (or failure    to act) preserves the
                             - 137 -

sanctity of the court and safeguards the public’s confidence in
the judicial process.

               *    *    *    *    *    *    *

     ABA Model Rule 4.1 provides, in part, that in the course of
representing a client, a lawyer shall not knowingly make a false
statement of material fact or law to a third person, or fail to
disclose a material fact when disclosure is necessary to avoid
assisting a criminal or fraudulent act by a client, unless
disclosure is prohibited under ABA Model Rule 1.6 regarding
client-lawyer confidentiality.

     * * * It is also professional misconduct under Rule 8.4 for a
lawyer to engage in conduct involving dishonesty, fraud, deceit or
misrepresentation. Similarly, under Rule 8.4, it is professional
misconduct for a lawyer to engage in conduct that is prejudicial
to the administration of justice.

     * * *[In Dixon V],the Ninth Circuit imposed sanctions against
respondent because two Chief Counsel attorneys committed fraud on
the Tax Court during the trial of the cases. Briefly, the Chief
Counsel attorneys entered into secret settlements with two of the
test case petitioners and a witness in the trial of a group of
test cases intended to resolve a large tax shelter litigation
project. Although the settlements were all different, some
noteworthy terms included an agreement that the settled test cases
would nonetheless proceed to trial; that the petitioners would
testify for the respondent; and in one test case, that any
deficiencies would be reduced by the amount of the petitioner’s
attorneys fees. With respect to the settling witness who
testified for respondent at the trial of the test cases, the
witness’s deficiencies were conceded in full by respondent
following the test case trial.

     These settlements were not disclosed to the Tax Court or to
the other taxpayers in the tax shelter litigation project who had
agreed to be bound by the outcome of the test cases.

               *    *    *    *    *    *    *

     * * * All Chief Counsel attorneys are expected to carry out
their responsibilities with the utmost integrity. Clearly, the
conduct of the Chief Counsel attorneys in Dixon fell far short of
those high standards. * * *
