T.C. M em o . 2 0 2 1 -7 6

UNITED STATES TAX COURT

M ICHAEL R. KELLY, Pet i t i o ner v . COM M ISSIONER OF INTERNAL REVENUE, Res po n d en t

Do ck etNo s . 6 2 2 5 -1 6 , 1 6 8 47 -1 6
. Fi l edJ u n e 2 8 , 2 0 2 1
.

Kev an P. M cLau g h l i n an dPh i l l i p L. J el s m a, fo r p et i t i o n er. M o n i ca D. Po l o , Do n n a L. Cro s b y , Vl ad i s l av M
. Ro zen zh ak , M o n i ca Cen dejas , an dCl i n t o n M . Cro s s er, fo r res po n den t
.

M EM ORANDUM FINDINGS OF FACT AND OPINION GOEKE, Ju d g e: Inthes e co n s o l i d at edcas es , res p o nd en t i s s ued t wo n o t i ces
o f d efi ci en cy d et erm i n i n g th e fo l l o wi n g d efi ci en ci es an dp en al t ies :

Served 06/28/21- 2
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Year Defi ci en cy Pen al t y s ec. 6 6 6 3 2 00 7 $ 6 ,7 23 ,1 8 1 $ 4 ,5 0 5 ,2 8 9 2 0 0 8 3 ,3 59 ,3 2 2 2 ,4 60 ,0 1 7 2 0 0 9 1 ,4 81 ,9 1 7 1 ,0 51 ,2 3 9 2 0 1 0 2 7 ,9 53 ,4 8 8 2 0 ,8 97 ,1 6 2 2 0 1 1 1 5 8 ,6 6 1 1 1 8 , 9 9 6 In th e al t ern at i v e t o th e frau dp en al ti es , res p o nd en td et erm i ned2 0 %
accu racy -rel at edp en al ti es u n d er s ect i o n 6 6 6 2(a) 1 fo r each o f t h e y ears ati s s u e. Vari o u s s m al l er i ss u es i n cl u d edi n t h e ab o v e d efi ci en cy d et erm i n at io n s h av e b een set t l ed , an dM r. Kel l y ch o s e n o tt o ch al l en g e s ev eral o th er s m al l er i s s u es o n b ri ef. Th e p ri n ci p al i s s u es rem ai n i n g i n d i s p u t e i n v o l v e M r. Kel l y ’ s t ran s fers o f fu n d s b et ween co rp o rat i o n s h e o wn edan dth e t ax t reat m en to f t h o se t ran s act i o n s . Th e t ran s act io ns are fact u al l y co m p l ex . Fo r t he fi rs tth ree y ears th ere are s t atu te o f l i m i tat i on s i ss ues an dd et erm i n at io n s o f frau d . Res p o n d en th as co n ced edth e p en al t i es fo r t ax y ears 2 01 0 an d2 0 1 1 b ecau s e h e d i dn o t es t ab l i s h t h atwri t t en
s up erv i s o ry

ap p ro v al was o b t ai n edas req u i redb y s ect i o n 6 7 51 (b ). [* 2 ]

1 Un l es s o t h erwi s e i nd i cat ed , al l s ect i o n referen ces are t o th e In t ern al Rev enu e Co de, t i t l e 2 6 , U.S.C., i n effect fo r t h e y ears ati s s ue, an dal l Ru l e referen ces are t o th e Tax Co u rtRu l es o f Pract i ce an dPro cedu re. So m e d o l l ar am ou n t s are ro u n ded
.- 3
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[* 3 ] Th e i s s u es rem ai n i n g fo r d eci s i o n are m o re s p eci fi cal ly s t at edas fo l l o ws . (1 ) W ere t ran s fers fro m Nat i o n al Serv i ce In du st ri es , In c. (NSI), t o Kel l y Cap it al , LLC (Kel l y

Cap i tal ), b o n a fi d e l oan s , o r s h o u ld t he am o u ntb y wh i ch th e tran s fers ex ceed edM r. Kel l y ’ s ad ju s t edb as i s i n NSI b e treat edas t ax ab l e cap i t al g ai n fo r t h e res p ect i v e t ax y ears ? Th i s i s s u e fu rt her rel at es t o t h e b ro ad er q u es t i o n
o f wh eth er th e fu n d s t ran s ferred t o M r. Kel ly an dh i s co m

p an i es were b o n a fi d e l o an s o r s h o u l db e t reat edas d i s t ri b ut i o n s . W e h o l d t hattran s fers aft er 2 0 0 7 were
n o tl o an s b u trat h er d i s t ri bu t i o n s v al u edat t h e face am ou n t s o f t h e fu n d s tran s ferred
. (2 ) To th e ex t en t th atth e fu nd s t ran s ferred t o M r. Kel ly an dh i s co m

p an i es were b o n a fi d e l o an s , d i d M r. Kel l y recei v e t ax ab l e d i s t ri b u t i on s wh en th e l o an s
were can cel ed , an di f s o , wh atwas th e v al u e o f t h e d i st ri b u t edp ro pert y ? W e h o l d th atM r. Kel l y

recei v edt ax ab l e d i s t ri b ut i on s t o th e ex t en twe h av e fo u n dth atth e l o an s were b o na fi d e an dth e d i s t ri b u t i o n am o u n t s are t h e face v al u es o f t h e l o an s . (3 ) Fo r t ax y ear 2 01 0 , t o th e ex t en tth atl oan s ex i st ed , d i d M r. Kel ly h av e t ax ab l e can cel lat i o n o f d eb t (COD) i n co m e, o r was h e i n s o l v en t s uch th atth e d i s ch arg e o f i nd eb t ed n es s i s n o ti n cl u d ab l e i n h i s g ro s s i n co m e u n d er s ect i o n 1 0 8 (a)(1 )(B)? W e h o l dth atM r. Kel l y ’ s i ns o lv en cy co m p ut at io n fo r 2 0 1 0 req u i res th e el i m i nat i o n o f l o an s t o h i m fro m h i s cl os el y

h el dco m pan i es . Acco rd i n g l y , we- 4
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[* 4 ] h o l dth ath i s COD i n co m e i s o v ers t at ed , an dth e p art i es m u s t co m pu t e t h e i n s o l v en cy am o u n t i n th e Ru l e 1 5 5 co m p ut at io n s i n acco rd an ce wi t h o ur h o l d i n g s h erei n . (4 ) In ex t ri cab l y

l i nk edt o t h e fi rs tth ree i s su es i s th e ques t i o n o f wh et h er M r. Kel l y i s en t i t l edt o a n o nb u si n es s b add eb t d edu ct i o n fo r t ax y ear 2 0 1 0
. W e h o l d M r. Kel l y h as n ot es t ab l i s h edth ath e i s en t i t l edt o a n o nb u s i n es s b add eb t d educt i o n . (5 ) Fo r t ax y ears 2 01 0 an d2 0 1 1 , d i d Kel l y Cap i t al h av e ad di ti o n al t ax ab l e i n co m e o n th e b as i s o f d ep o s i t s i n i ts b an kacco u n ts , o r were t h e d ep os i t s fro m b o n a fi d e l oan s o r o t h er n o nt ax ab l e s o u rces ? W e h ol d t h ere was n o ad d it i o n al i n co m e. (6 ) Fo r t ax y ear 2 00 9 , i s M r. Kel l y en t i t l edt o a l o s s d edu ct io n fo r fo rg i v en l o an s m ad e p ri m ari ly

t o h i s b ro t h er an dth e Bi t t er En d , In c. (TBE)? W e h o l dM r. Kel l y h as fai l edt o es tab l i s h s u ch a d educt i o n s h o u l db e p erm i t t ed
. (7 ) Fo r t ax y ear 2 01 0 , i s Vi rtu co n , LLC (Vi rtu co n ), al l o wedt o d edu ct $ 1 ,4 8 2 ,3 3 4 i n i n t eres t rel at edt o i t s o wn ers h i p o f an ai rp l an e? W e h o l d t he d educt i o n i s n o t p ro p er.- 5
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[* 5 ] (8 ) Fo r t ax y ears 2 01 0 an d2 0 1 1 , i s Kel l y Yach t& Ch art er, Lt d. (KY&C),
en t i t l edt o d edu ctv ari o u s ex pen s es i n cl u d i n g t h o se p ai dwi t h b o rro w edfu n d s ? W e h o l dth e d edu ct i o n s are p ro p er. (9 ) Fo r t ax y ear 2 01 0 , are t h e fo l lo wi n g d edu ct i o n s al l o w edfo r Lem o n Bay Ho ri zo ns , LLC (LBHo ri zo ns ), th e d ev el o p er o f s ev eral Fl o ri da co n d o m i n i um s ?

Ex p en s e Am o u n t In t eres t/ o t her $ 1 5 6 , 4 05 Tax es an dl i cen s es 5 3,3 1 4 Oth er 1 9 ,9 4 3 W e h o l dth i s treat m en ti s p ro per. (1 0 ) Fo r t ax y ears 2 0 10 an d2 0 1 1, i s M r. Kel l y en ti t ledt o p as s iv e act i v i t y l o s s d edu ct i o n s fro m

Fro n tSt reetIn ves t m en t Fu n d , LLC (FSIF), t o n et ag ai n s t p as s i v e act i v i t y

i nco m e? Si m i l arl y , fo r t ax y ear 2 01 0 , i s M r. Kel l y en t i t l edt o d educts u s p en dedan du nu s edp as s i v e act iv it y l o s s es fro m Rad i u s M o rt gag e Cap it al , LLC (Rad i us M o rt g ag e)? Th e d educt i o ns are al l o wedt o t h e ex t en t al l o wab le i n t he Ru l e 1 55 co m p u t at i o n s . (1 1 ) Has res p o n d en tp ro v en , fo r t ax y ears 2 0 0 7 , 2 0 0 8 , an d 2 0 0 9 , b y cl ear
an d co n v i n ci n g ev i den ce, t h atM r. Kel l y u n derp ai dh i s t ax an dth ats o m e p arto f th e u n derp aym en t fo r each y ear was du e t o frau d ? Inth e al t ern at iv e t o the s ect i on- 6
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[* 6 ] 6 6 6 3 frau dp en al t y

fo r t ax y ear 2 00 9 , i s M r. Kel ly l i ab le fo r an accu racy rel at ed p en al t y

u n d er s ect io n 6 6 6 2 (a)? W e h o l dth e frau dp en al t y i s n o t s u s t ai n ed fo r 2 0 0 7 , 2 0 08 , o r 2 00 9 an d fu rt h er h o l d t hati f t h ere i s a 2 5 % o m i ss i o n fro m g ro s s i n co m e fo r 2 0 09 , th e s ect io n 6 66 2 (a) p en al t y ap p l ies fo r t h aty ear. (1 2 ) Fo r t ax y ears 2 0 07 , 2 0 0 8 , an d2 0 0 9, d i dres p o n d en tt im el y i s su e t h e
n o t i ce o f d efi ci en cy

u n d er s ect i o n 6 5 0 1 (a)? W e h o ldth atth e d efi ci en cy n o t i ce i s
u n t i m el y fo r 2 00 7 an d2 00 8 an dth e s t atu s fo r 2 0 09 d ep en d s o n wh et her a 2 5 %
o m is s i o n o f g ro s s i n co m e u nd er s ect i o n 6 5 0 1(e)(1 ) i s s u s t ai n edi n t h e Ru l e 1 5 5
co m p u t at i o n s . (1 3 ) W as M r. Kel l y ’ s fai l u re t o t i m el y fi l e Fo rm s 5 4 7 1 , In fo rm at i o n Retu rn
o f U.S. Pers on s W i t h Res p ectt o Cert ai n Fo rei g n Co rp o rat i o n s , fo r t ax y ears 2 0 0 8
an d 2 0 0 9 th e res u lto f reas o n ab l e cau s e an dn o twi l lfu l n eg l ect ? W e h o l d t h ere
was reas o n ab l e cau s e. Al l o t her u ns et t ledi s s u es are co m p u t at i o n al
. 2

2 To th e ex t en tth atth e u n ad dres s edi s s u es are u n res o l vedan d are n o t co m p u t at i o n al , M r. Kel l y

h as co n ced edth em

o n th e b as is o f h i s fai l u re t o ad dres s th em o n b ri ef, i n cl u d i n g l o s s es rep o rt ed o n Sch edul es E, Sup p l em en t al In co m e an d Lo s s , at t ach edt o h i s p ers o n al retu rn s fo r 2 0 10 an d 2 0 1 1
.- 7
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[* 7 ] FINDINGS OF FACT Th e p art i es h av e s t ip ul at edfact s wh i ch are i n co rp o rat ed h erei n b y th i s referen ce. Wh en t h e p et i t i o n s were t i m el y fi l ed , M r. Kel l y res i dedi n Cal ifo rn i a. M r. Kel l y ’ s fi rs tex peri en ce i n b u y i n g an ds el l i n g co m p an i es cam e wh en h e b o u g h ta s po rt i n g g o o d s s t o re fo r $ 2 5 ,0 0 0 i n th e 1 98 0 s th ath e s u cces s fu l l y res o l d fo r a $ 5 0 ,0 0 0 p ro fi t . Inth e earl y 1 9 9 0 s M r. Kel l y ’ s fat h er p u rch as eda $ 1 5 0
m i l l io n p o rt fo l i o o f l o an s fro m a b an krup t cy

recei v er fo r $ 7 5 m i l l i o n an das k ed M r. Kel l y t o jo i n h i m

i n res el l i n g th e l o an s . M r. Kel ly m o v edfro m

Cal i fo rn i a t o Ari zo n a an d b eg an t o l earn the p ro ces s o f fl ip p i n g l o an s u n d er t h e tu t el ag e o f h i s fat h er an d Ro b ertJ aco b so n , a l awy er as s i s t i n g i n th e t ran s act i o n s . M r. Kel l y v i s i t edv ari o u s b an ks , m etwi t h th ei r p res i d en ts o r m an ag ers , an d tri ed to res el l the l o an s fo r m o re t han th e d i s co u n t edp u rch as e p ri ces . M r. Kel l y d ev el o p ed a p ers on al an d p ro fes s i o n al rel at i on s h i p wi t h th e o wn ers o f o ne s u ch b an k, M o u nt ai n Co m

m u n i ty Ban k , wh i ch wo u l db eco m e o n e o f M r. Kel l y ’ s fu tu re l en d ers . M r. Kel l y

was p ai d 5 % o f n etp ro ceed s fro m the s al e o f t he l oan s fo r h i s effo rt s . M r. Kel l y ’ s u n d ers t an d i n g o f fl ip pi n g l o an s p ro g res s ed , an dh e was s o o n ab l e t o cap it al i ze o n o th er l o an p o rt fo l i os . He b eg an b id d i n g o n s m al ler l o an p o rt fo l i o s. Wh i l e wo rk in g fo r h i s fat h er, M r. Kel ly b eg an co l l ect i n g fro m s o m e- 8
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[* 8 ] d eb to rs , wo rk i n g o u tl oan s wi t h b orro wers , o r t ak in g o wn ers h i p o f t h e
u n d erl y i n g p ro p ert y

i n fo recl o s u re. I. Earl y

Bu s i n es s Op erat i o ns So m et i m e aro u n d 1 9 9 3 M r. Kel l y an dh i s fat h er’ s b u s in es s rel at io n s h i p d et eri o rat ed . M r. Kel l y retu rn edt o Cal ifo rn i a an db eg ana s i m i l ar l o an trad i n g b u s i n es s wi t h h i s b ro t h er, Ri ch ard
. InAu g u s t1 9 9 3 t h e b ro t h ers s etup Fi rs t Co m m erci al Co rp . (FCC), an S co rp o rat io n , wi t h each b ro th er o wn i n g an equ al
s h are. Ov er t i m e, M r. Kel l y ’ s o wn ers h i p o f FCC i n creas ed . By 2 0 0 9 M r. Kel l y
o wn ed6 6.1 % an dRi ch ardo wn ed3 3 .9 %, an d i n 2 0 1 0 an d2 0 11 M r. Kel l y o wn ed 7 5 % an d Ri ch ardo wn ed2 5 %. On e o f t h e b ro t h ers ’ fi rs tb u s i nes s es was a San Di eg o b ar. In o r aro u n d 1 9 9 5 M r. Kel l y

i d en ti fi eda l o cal b ar, t h e Ori en t , as a p os s i b l e b u s i n es s v en tu re. OnJ an u ary

1 0 , 1 9 9 5 , th e b ro th ers o rg an izeda s p eci al p u rp o se en t i t y , TBE, t o p u rch as e an dh o l dth e l i qu o r l icen s e an dt o o p erat e t he b ar. M r. Kel l y b o rro wed $ 2 5 0 ,0 0 0 fro m

FCC t o p u rch as e t h e l i qu o r l i cen s e. TBE b o rro wed$ 2 m i l l i o n fro m M o u n t ai n Co m

m u n i ty Ban kt o ren o v at e th e b ar’ s t h ree-s t o ry b u i l di n g . FCC
an d M r. Kel l y p ers on al l y g u aran t eedth e l o an . Th e l o an was ev en tu al l y rep ai d . In 2 0 0 7 an d2 0 0 8 , M r. Kel ly o wn ed5 1 % o f TBE an dRi ch ard o wn ed4 9 %. Duri n g- 9
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[* 9 ] 2 0 0 9 Ri ch ard ’ s o wn ers h i p i n creas ed t o 7 7 .6 %, M r. Kel l y o wn ed1 8.2 %, an d th ree o th er i n d i v i du al s o wn ed t h e rem ai n der. An o th er jo i n tv en tu re o f t h e b ro t h ers was Lu cky Bas t ardReco rd s , LLC (Lu cky Bas t ardReco rd s ), a co m p an y es t ab l i s h edt o p ro du ce an dp ro m o t e a b an d
. M r. Kel l y an d Ri ch ardeach o wn ed5 0 % o f Lu cky Bas t ardReco rd s . FCC ad v an cedm o n ey

t o Lu cky Bas t ardReco rd s, wh i ch FCC reco rd edas a d eb t , an das
o f Decem b er 3 1 , 2 0 0 7 , Lu cky

Bas t ardReco rd s o w ed$ 9 5 2 , 3 9 3 t o FCC. Fo r t ax y ear 2 0 0 7 , M r. Kel l y rep o rt edo v er $ 75 ,0 0 0 o f n o np as s i v e i n co m e at t ri b u t ab l e t o Lu cky Bas tardReco rd s . A. No nperfo rm i n g Lo an s In th e l at e 1 9 9 0s M r. Kel l y b eg an fo cu s i n g h i s i n ves t m en tact i v i t y o n as s et s
u s ed as s ecu ri t y

fo r n o np erfo rm i n g l o an s an dthe v al u e o f th e as s et s rel at iv e t o th e l o an s ’ v al u es . Th e u n d erl y i n g as s et s b ecam e m o re i m p o rt an t
. M r. Kel l y

en g ag ed i n s o m e o f t h es e v en tu res th ro u g h FCC an d i n o t hers o n h i s o wn . Th e as s et s ty p i cal l y i n cl ud eda b u s i n es s en t i t y wi t h as s o ci at edreal es t at e. M r. Kel l y wo u l d fo recl o s e o n t he co l l at eral , m ak e i m pro v em en t s t o th e b u s i n es s an dp ro p ert y , an d th en ei th er o p erat e t h e b u s i n es s o r res el l i t . M r. Kel l y i n i t i al l y b o rro wed m o n ey fro m th i rd -p art y

l en d ers t o fi n an ce t h e p u rch as e o f th e n onp erfo rm i n g l o an s . M r. Kel l y o b t ai n edl o an s fro m

h is o l dfri en d s atM ou n tai n Co m m u n i t y Ban k . He al s o- 1 0 -

[* 1 0 ] o b t ai n ed l o an s fro m Frem o n tIn v es t m en t& Lo an , Fo rt res s , 3 an d Fi rs t Am eri can Ban k. He d ev el o p eda h i s t ory o f rep ay i n g t h es e l en d ers an d rei n v es t i n g th e rem ai n i n g s al e p ro ceed s i n h i s n ex tb u s i n es s v en tu re. He ap p ro ach edeach d eal wi th the p l an t o u s e t he p ro ceed s t o fi n an ce t h e n ex t , h o p efu l l y b i g g er, d eal , wi th m an y

s u cces s fu l s al es o f h i s b u s i n es s i n v es t m en t s . In a t y p ical tran sact i o n , M r. Kel l y wo u l d , i n p artatth e req u es to f t h e l en d ers , s etup t wo s p eci al p u rp o s e en t i t i es : o n e t o o wnth e fo recl o s edreal es t at e
an d o n e t o m an ag e an y

b u s i n es s o p erat i o n s co n n ect edwi t h th e real es t at e. On e o f th e g o al s was t o i s o l at e th e ri sk s fro m th e b u s i n es s o p erat i on s fro m th e real es t at e, wh i ch th e l en d ers g en eral l y v al u edm o re. Ul t i m at el y , FCC t rad edo v er $ 3 .3 b i l l i o n i n l o an s an dreal es t at e b et ween 1 9 9 3 an d 2 0 0 3 an dacq u i redn u m ero u s real
es t at e p ro ject s t h ro u g h ou tCal i fo rn i a i n cl ud i n g res i d en ti al d ev el o p m en t s i n Oran g e Gro ve, res i d en t i al l o t s i n M o ren o Val l ey , l o ts i n Rai nbo w, v acan t o ffi ce b u i l d i n g s , an d s tri p -m al l s h o p p i n g areas . In 2 0 0 4 M r. Kel l y

d eci d edt o s t arth i s o wnco m p an y wi t h ou th is b ro t h er, t o
o p erat e t h e s am e way

th at FCC h ado p erat ed . OnSep t em b er 2 9 , 2 0 04 , M r. Kel l y
o rg an i zedKel l y

Cap i t al as a s i n g l e-m em

b er l i m i t edl i ab i l it y

co m p an y (LLC). M r.

3 Th e reco rdrefers t o l o an s fro m an d/ o r as s i g n edb y o r t o Fo rt res s Cred i t Co rp ., Fo rt res s In ves t m en t , an dFo rt res s Fi n an ci al
. Fo r co n v en i en ce, we refer t o th es e t hree en t i t i es co l l ect i vel y as Fo rt res s.- 1 1 -

[* 1 1 ] Kel l y

was th e s o l e m em

b er fro m i t s o rg an i zat i o n thro u g h th e y ears ati s s u e. He s h ift edFCC’ s act i v i t i es an dem p l o y ees t o Kel l y

Cap i t al
. Ho wev er, FCC
co n ti n u edi n ex i s t en ce. FCC’ s reco rd s fo r 2 0 0 7 refl ect ed$ 3 , 8 8 3 ,5 6 7 an d $ 4 ,4 6 2 ,4 4 6 du e fro m

thes e en t it i es , res p ect i v el y , wh i ch FCC wro t e o ff as b ad d eb ts fo r t h e 2 00 7 t ax y ear. Ul t i m at el y , M r. Kel l y

s etup o v er 2 5 cl o s el y

h el dco m p an i es , m an y

as
s i ng l e-m em

b er LLCs , th ath e o wn edan d co n t ro ll ed(affi l i at edco m p an i es ). He b eg ant o tran s fer m on ey

b et ween h is affi li at edco m pan i es t o fu ndh i s b u s i n es s
v en tu res an dreco rd edth e t ran s fers as l o an s . He d i d n o tcau s e h i s s i n g le-m em b er LLCs t o fi l e en t it y -l ev el return s . In s t ead , h e rep o rt edth e t ax i t em s o f each s i n g l em em b er LLC o n a Sch edu l e C, Pro fi to r Lo s s Fro m Bu s i nes s , at t ach edt o h i s p ers o n al retu rn . Fo r 2 0 0 7 Kel l y Cap it al rep o rt eda p ro fi t o f ap pro x i m at el y $ 2 .7
m i l l io n wi t h recei p t s o f $ 1 3 m i l l i o n . Ho wev er, fo r 2 0 0 8 , 2 0 0 9 , an d2 0 1 0 i t rep o rt edl o s ses o f $ 1 .5 m i l l i on , $ 8 m i l li o n, an d $ 1.1 m i l l i o n , res p ect i v el y , wi t h g ro s s recei p ts o f $ 2 m i l li o n , $ 5 0 0 , 0 0 0 an d$ 4 m i l l i o n , res p ect i v el y . B. Acco u n t i n g Act i v i t i es FCC u s edthe n om en cl atu re “ du e t o ” an d“ du e fro m ” t o trackh o w m u ch
m o ney was o w edb et w een M r. Kel l y ’ s affi l i at edco m p an i es . In i ti al ly , FCC u s ed th e o u ts i d e acco un t i n g s erv i ces o f Ro b ertReg n ery atKen n et h Lev en t h al & Co .,- 1 2 -

[* 1 2 ] wh o l at er b ecam e FCC’ s ch i ef fi n an ci al o ffi cer (CFO). M r. Reg n ery l i k el y i n tro du cedth e “ du e t o ” an d“ du e fro m ” m et h odt o t rackth e t ran s fers b et ween M r. Kel l y ’ s affi l i at edco m

p an ies
. M r. Kel l y ’ s affi l i at edco m pan i es co n s i s t en t l y ad h ered to th i s m et ho dt o t racktran s fers duri n g th e y ears at i s s u e. In 1 99 4 FCC h i redJ o s ep h Th om as as a s t aff acco u n tan t . He was t ran s ferred t o Kel l y Cap i t al , wh ere h e wo rk ed du ri n g th e y ears ati ss u e. In h i s earl y ro l e, h e was th e p ers o n o n th e acco u n t i n g s taff t o reco rdthes e t ran s act i o n s . Lat er, h e s erv ed as v i ce p res i d en t
an d s en i o r v i ce p res i d en t co n t ro l l er, an d h i s res p on s i bi l i t ies co n s i st edo f
o v ers eei n g th e co m

p an y ’ s cas hfl o w , fi nan ci al s , b an kreco n ci l i at io n s, an d i n v es t m en t s t o en s u re t h e i n fo rm at i o n th at was p ro v i d edt o M r. Kel l y fo r fi n an ci al rep o rt s was accu rat e. M r. Th o m as ty p i cal l y p rep aredM r. Kel l y ’ s p ers o n al fi nan ci al s t at em en t s . Ov er t h e d ecad es o f th ei r o perat i o n s , M r. Kel l y ’ s co m p an i es d ev el o p ed
acco u n t in g d ep art m en t s t h atem p l o y edqu al i fi edp ro fes s io n al s . Th ey al so
em pl o y edi n -h o u s e l eg al co u n s el . In1 9 9 9 Ch arl es Bl o tt i n rep l aced M r. Reg n ery
as FCC’ s CFO, an dh e ev en tu al l y m o v edt o Kel l y Cap i t al . InAu g u s t2 0 0 5 M r. Bo wen rep l aced M r. Bl o t t i n an ds erv edu n t i l h i s d ep artu re aro un dDecem ber 2 0 1 8. M r. Bo w en h as b een a cert i fi edp ub l i c acco u n t an t(C.P.A.) s i n ce 1 9 8 4 an dh as an
ex t en s i v e career as an acco un t an t . M r. Th o m as rep o rt edt o th e CFOs i n cl u d i n g- 1 3 -

[* 1 3 ] M r. Bo wen . M i ch ael M ark s , an at t o rn ey , wo rk edfo r FCC an d l at er Kel l y Cap it al fro m

2 00 2 t o 2 0 12 , s erv i n g as g en eral co un s el duri n g m o s to f t h att i m e
ex cep tfo r wh en Lo ui s Al o n s o s erv edas g en eral co u n sel du ri n g 2 0 0 7 th ro u g h 2 0 0 9
. II. M r. Kel l y ’ s Bu s i n es s Ven tu res In 1 9 9 7 M r. Kel l y

p urch as eda $ 2 8 m i l li o n n o np erfo rm i n g l o an s ecu redb y a h o t el i n Kau ai , Hawai i , fo r $ 2 .8 m i ll i on . He fo recl o s edo n th e l o an . Paci fi c Ri m Part ners was o rg an i zedt o o wnth e h o t el , an dPaci fi c Co as tPart n ers , LLC (Paci fi c Co as t ), was o rg an i zedt o m an ag e t h e h o t el ; i tch an g edth e n am e t o Kel l y Ho s pi t al i ty , LLC (Kel l y

Ho s p i t al i t y ), i n 2 00 7 . Fro m th e d at e o f reg i s trat i o n , Oct o b er 3 1 , 1 9 9 7 , th ro u gh Decem b er 3 1 , 2 0 1 1 , M r. Kel l y

was th e s o l e m em

b er o f Paci fi c Co as tan dKel l y

Ho s p i t al i t y . Fo r co n v en ien ce we refer t o t h es e t wo
en t i t i es co l l ect i v el y

as Kel l y Ho s p i tal i t y . In 1 9 9 8 M r. Kel l y

acq ui reda n o np erfo rm i n g l o an s ecu redb y 1 ,8 6 8 acres o f real es t at e i n J ul i an , Cal ifo rn i a. M r. Kel l y b o rro wedro ug h l y

$ 3 m i l l i o n t o acq u i re th e l o an an dth en fo recl o s edo n t h e p ro p erty . OnFeb ru ary 1 0 , 1 9 9 8 , J u l i an Co u n try Es t at es , LLC (J CE), was o rg an izedt o o wnth e real es t at e, wi t h M r. Kel l y
an d Ri ch ard each o wn in g 5 0 % . Aro u n d2 0 0 2 J CE s o l dthe real es t at e fo r ro u g h l y- 1 4 -

[* 1 4 ] $ 9 .2 m il l i o n , an d M r. Kel l y rei n v es t ed t h e p ro ceed s i n a h o t el ad jacen tt o TBE’ s b ar kno wnas t h e Iv y Ho t el , d i scu s s ed fu rt h er b el o w. An o th er b u s i n es s v en ture o f M r. Kel l y was FatCi t y , a 1 40 ,0 0 0 -s qu are-fo ot fam i l y en t ert ai n m en tcen t er i n Li t tl et o n , Co l o rad o , wh i ch FCC acq u i redb y p u rch as in g a $ 2 5 m i l l i o n n o np erfo rm in g l o an fo r ro ug h l y $ 2 m i l l i o n . On J an u ary 1 , 1 99 9 , Green b ackHo l d i n g s, LLC (Green b ackHo ld i n g s ), was o rg an i zedas a
s p eci al p u rp o s e en t i t y

t o h o l dth e en t ert ai n m en tcen t er. Cu t th ro at En t ert ai n m en t , In c., wh i ch l at er ch an g edi t s n am e t o Green backEn t ert ai nm en t , In c. (Green b ack En t ert ai nm en t ), anS co rp o rat i o n , was o rg an i zedt o m an ag e an do p erat e th e b u s i n es s , s ep arat i n g th e o wn ers h i p o f t h e real es tat e an dth e m an ag em en to f b u s i n es s o p erat i o n s i n two en t it i es i n acco rd an ce wi t h M r. Kel ly ’ s t y p i cal p ract i ce. M r. Kel l y an d h i s en t i ti es b o rro wedro ug h ly $ 1 0 m i l l i o n an d i n v es t ed i ti n FatCi t y
an d o p erat edth e b us i n es s fo r s ev en y ears . Aro u n d 2 0 0 8 M r. Kel l y s o ldFatCi t y , u s ed th e p ro ceed s t o rep ay ex i s t i n g l i ab i l i t i es , an drei n v es t edth e rem ai n i n g fu n d s i n h i s o th er b u s i n es s es . Green b ackEn t ert ai n m en tco n t i n u edi n ex i s ten ce, an d du ri n g 2 0 0 9 th ro u g h 2 0 1 1 i twas wh o l l y o wn edb y

M r. Kel ly . Green b ack En t ert ai nm en t reco rd edi n t erco m p an y tran s fers t o an dfro m

M r. Kel l y ’ s affi l i at ed
co m p an i es i n cl u d i n g a $ 1 .7 m i l l i o n tran s fer t o Kel l y Cap i t al . As o f t h e en do f- 1 5 -

[* 1 5 ] 2 0 1 0 , Green b ackEn t ert ai n m en th adam o u nt s du e t o Kel l y Cap it al o f ap p ro x i m at el y $ 2 m i l l i o n acco rd i n g t o Kel ly Cap i t al ’ s reco rd s . In an o t h er t ran s act i on , M r. Kel ly p u rch as eda n o np erfo rm i n g l o an s ecu red b y a g o l f co u rs e n ear M o d es to , Cal i fo rn i a, an dfo recl o s ed o n th e p ro p ert y . Hi d d en Hi l l s Ho ld i n g s was o rg an i zedas th e s p eci al p u rp o se en t i t y t o o wnth e g o l f co u rs e,
an d Hi d d en Hi l l s Res o rtwas o rg an i zed t o o p erat e t h e g o l f co u rs e. In i t i al l y , M r. Kel l y an dRi ch ardeach o wn ed5 0 % o f Hi d d en Hi l l s Ho l di n g, an dM r. Kel l y
o wn ed1 00 % o f Hi dd en Hi ll s Res o rt . M r. Kel l y ren o v at edthe p ro p ert y , i ns t al l i n g cart p ath s an dfi x i n g up th e cl ub h ou s e t o i ncreas e g ol fer t raffi c. M r. Kel ly
ev en tu al l y

s o l d th e g ol f co u rs e, ap p aren t l y ata l o s s . FCC t ran s ferred m o n ey t o Hi d den Hi l l s Ho l di ng s an d Hi d d en Hi l l s Res ort
. In J u n e 2 0 03 M r. Kel l y

acq u i redh i s fi rs tp ubl i cl y t rad ed co m p an y , NSI, a Del aware co rp o rat i o n (NSI-DE), fo r $ 1 1 3 m i l li o n (NSI acq u i s i t i o n), wi t h th e i n t en t i o n o f l i qu i d at i n g i t s as s et s an di n ves t i n g the p ro ceed s i n o t h er b u si n es s
v en tu res . M r. Kel l y

b orro wedth e p u rch as e p ri ce fro m i n s t i tu ti on al l en d ers an da p ri v at e i n v es t o r. He p ers on al l y g u aran t eedth es e l oan s . He g av e a 5 % o wn ers h i p i n t eres ti n NSI-DE t o Dav i d Ni co l as Sp ri g g s II t o co m p en s at e M r. Sp ri gg s fo r h i s
wo rki n i d en t i fy i n g NSI-DE as a p o s s i b l e t arg etan dh i s as s i s t an ce wi t h t he acq u is i t io n p ro ces s . M r. Sp ri g g s h adb een wo rk i n g wi t h M r. Kel l y an dRi ch ard- 1 6 -

[* 1 6 ] s i n ce 1 9 9 9. Aro u ndth e t i m e o f t h e NSI acq ui s i t i o n , M r. Kel ly o rg an i zed Kel l y Cap i t al as a s i n g l e-m em

b er LLC, an do n J an u ary 2 6 , 2 0 0 7 , h e t ran sferred h i s 9 5 % i n t eres ti n NSI-DE t o Kel l y Cap i t al
. Ats o m e p o i n t , M r. Kel l y cau s edNSI-DE t o o rg an i ze a Cal i fo rn i a
co rp o rat i o n b y

th e s am e n am e as a wh o l l y o wn eds ub s i d i ary

(NSI-CA). NSI-DE
an d NSI-CA fi l ed co n so l i dat edS co rp o rat i o n retu rn s fo r t h e y ears ati s su e. In M ay 2 0 1 2 NSI-CA ch an g edi t s n am e t o En g l ewo odHo ld i n gs Co rp . (En g lewo o d). W e refer t o th e Del aware p aren t co m p an y as NSI-DE, th e Cal i fo rn i a s ub s i d i ary as NSI-CA, an dth e t wo en t i ti es co l l ect i v el y as NSI. Befo re 2 0 0 1 NSI was a d i v ers i fi edco n g l o m erat e en g ag edi n v ari o u s b u s i n es s es . In 2 0 0 1 NSI d eci dedt o s pi n o ff v ari o u s b u s i n es s es i n t o a s ep arat e p ub l i cl y trad edco m

p an y . Wh enM r. Kel l y

acq u i red NSI-DE, i ts b u s in es s
o p erat i o n s were u npro fi t ab l e b uti th adap pro x i m at el y $ 2 0 t o $ 3 0 m i l l i o n cas h o n h an d. Itp ri m ari l y

en g ag edi n t wo b u s i n es s areas , t ex t i l e ren t al s an den v el o p e
m an u fact u ri n g . NSI-DE’ s t ex t i l e ren t al act i v it y p ro v i d edn ap k i ns , t ab l e an db ed l i nen s , b at h t o w el s, p i l l o wcas es , b ar t owel s , s crub s an ds u rg i cal cl ot h s, m at s , m o ps , an dres t ro o m

s up pl i es t o d i n in g , l o d gi n g , an dh eal t h care cu s t o m ers th ro u g h Nat i o n al Li n en & Un i fo rm Serv i ce, LLC (Nat i o n al Li n en ). Th e en vel o p e
m an u fact u ri n g act i v i t y m ad e cu s t o m en vel o p es fo r cl i en t s i n th e en erg y , fi n an ce,- 1 7 -

[* 1 7 ] tran s p o rt at i on , d i rect m ai l , an dp ack ag e d el i v ery m ark et s t h ro u g h At l an t i c En v el o p e Co ., LLC (At lan t i c En v el op e). Nat i o n al Li n en an dAt lan t ic En v el o p e
o p erat edro u g h l y

7 7 p lan t s , al m o s tex cl u s i v el y eas to f th e M i s s i s s i p p i Ri v er, an d h ad ro ug h l y

6 , 5 0 0 t o 7 ,5 0 0 em

p l o y ees . Ato n e t im e NSI-DE o wn edNo rt h Bro t h ers , In c. (No rt h Bro t h ers ), a reg i o n al d i s t ri b u t or o f as b es t os -co nt ai n i n g i ns u l at i o n p ri m ari l y i n th e s o u th eas t ern Un i ted St at es an db ecam e s ub j ectt o cl ai m s o f l i ab il it i es rel at edt o th e as b es t o s p ro duct s s o l do r i ns t al ledb y No rt h Bro t h ers . Bet ween 1 97 2 an d2 0 0 2 NSI-DE recei v edo v er 1 8 7 ,0 0 0 as b es to s cl ai m s i n cl u d i n g 5 7 ,7 75 cl ai m s fi ledi n 2 0 01 an d 2 0 0 2 . As o f Decem

b er 3 1 , 2 0 0 2 , 2 5 ,4 66 cl ai m s were s t i l l p en d i n g . Cl ai m s
co n ti n u edt o b e fi l ed aft er t h e NSI acq u i s i t i o n an das o f Au gu s t 3 1 , 2 0 0 5 , th ere were 4 1 ,7 0 0 o p eno r p en d i n g as b es t o s cl ai m s . As o f J u l y 1 2 , 2 0 1 2, t he n u m

b er o f p en di n g as b es to s cl ai m s h ads h ru n kt o ap p ro x i m at el y 2 8 ,2 5 8. In 1 9 8 5 NSI en t eredi n t o an ag reem en twi t h 3 1 o t her p ro du cers o f as b es t o s
o r as b es t o s -co n t ai n i n g p ro du ct s an d1 6 i n s u rers , kn own as th e W el l i n g t o n Ag reem en t . Un d er i t s t erm s the As b es t o s Cl ai m s Faci l it y (ACF) was creat edas a
n o np ro fi tcl ai m s h an d l i n g cen ter t h atco ord i n at edcl ai m p aym en t s o n b eh al f o f d o zen s o f as b es t o s d efen d an t s . Th e p art i es t o th e W el l i n g t o n Ag reem en t , l i k e NSI-DE, s o u g h tt o redu ce as b es t o s l i t ig at i o n award s wh i l e l o weri n g th e as s o ci at ed- 1 8 -

[* 1 8 ] co st s b y

ag reei n g t o an al l o cat i o n fo rm u l a fo r al l cl ai m s wh ereb y each p art y ag reedt o p ay

a s h are o f ev ery

s et t l edo r ad

ju d i cat ed as bes t o s cl ai m

as s ert ed ag ai n s to n e o r m o re W el l in gt o n Ag reem en tp art i es i n acco rd an ce wi t h a p ro du cer al l o cat i o n fo rm

u l a wh et her o r n o tth e cl ai m an tal l eg ed ex po s ure t o the p art y ’ s
as b es t o s p ro du ct s . Thu s , th e W el l i n g t o n Ag reem en tav o i d edth e n eedt o as s ert
cro s s -cl ai m s ag ai n s tas b es t o s p ro du cers i n th e u n d erl y i n g as b es t o s l aws u i t s an d dro v e d o wnas s o ci at edd efen s e co s t s . OnOct o b er 6 , 1 9 88 , th e Cen t er fo r Cl ai m s Res o lu t i o n , In c. (CCR), was
o rg an i zedt o rep l ace ACF, wh i ch was o ffi ci al l y d i s s o l v edo n Oct o b er 3 , 1 9 8 8
. Th e CCR s ub s equ en t l y

d i s b an d edi n earl y

2 0 0 1 . Si n ce Feb ru ary

1 , 2 0 01 , NSI-DE d i rect l y ret ai n edat t o rn ey s t o d efen di t s el f fro m as b es t o s cl ai m s , en g ag i ng a l aw fi rm t o s erv e as n at i o nal co u n s el t o co o rd i n at e l o cal at to rn ey s t o d efen dNSI fro m
as b es t o s cl ai m s i n th e juri s di ct i o n s wh ere t h ey aro s e. NSI-DE al s o en g ag eda cl ai m s p ro ces s i n g an d ad m i n is t rat i o n s erv i ces . As p arto f t h e NSI acq ui s i t i o n du e d il i gen ce M r. Kel l y , b y an dth ro u g h h i s
co u ns el , requ es t eda rev i ew o f NSI-DE’ s as b es to s l i ab i l i t i es , rel at ed i n s u ran ce
co v erag e, an d o t h er fi n an ci al co n s i d erat io n s . OnM arch 1 9 , 2 00 3 , Pet ers o n Co n s u l t in g i s s u edan an al y si s o f NSI’ s as b es t o s l i ab i l i t i es (Pet ers on Co n s ul t i n g rep o rt ). Th e Pet ers o n Co ns u lt in g rep o rt es t i m at edth atNSI wo u l d p ay b et ween- 1 9 -

[* 1 9 ] $ 2 4 0 an d$ 26 2 m il l io n fo r i nd em ni t y co s t s an d$ 4 9 an d$ 81 m i l l i o n fo r d efen s e co s t s t o res o l v e al l p en d i n g an dfu tu re as b es to s cl ai m s fi l ed t h ro u g h 2 0 1 2
. Th e rep o rtal s o co n cl u d edth atal l b u t$ 1 6 m i l l io n o f NSI-DE’ s as bes t o s l i ab i l i t i es th ro u g h 2 0 1 4 wo u l d b e co v eredb y s o l v en ti n s u ran ce p ro v i d ers . Sp eci fi cal l y , th e Pet ers o n Co ns ul t i n g rep o rtco ncl u d edb y s t at i n g: Bas edo n o u r i n d ep en d en trev i ew o f NSI’ s h i s t o ri cal cl ai m s d at a, o u r ev al uat io n o f NSI’ s p en d i n g cl ai m s , an do u r es t i m at es o f NSI’ s fu tu re as b es t o s cl ai m s fi li ng s t h ro u g h 2 0 1 2 , we b el i ev e t h atNSI wi l l co n t in u e t o i ncu r l i ab i l i t y as s o ci at edwi t h as b es to s b o d i l y i n jury cl ai m s fo r the n ex t5 0 y ears . W e es t i m at e t he ran ge o f t ot al l iab i l i t y i n cu rredb y

NSI fo r as b es t o s b od i ly

i n j u ry cl ai m s fro m

2 0 0 3 th ro u g h 2 0 1 4 , fro m

cl ai m s fi l edth ro ug h 2 0 12 , t o b e ap p ro x im at el y $ 2 4 0 m i l l i o n t o $ 2 6 2 m i l l i o n an d fro m $ 4 9 m i ll i on t o $ 81 m il l i o n fo r d efen s e p aym en t s , fo r a t o t al o f fro m $ 2 8 9 m i l li o n t o $ 3 4 3 m i l l io n . W e es t i m at e th atal l b u t$ 1 6 m i l l i o n o f t h i s am o u n twi l l b e co v eredb y i n s u ran ce p ro v i d edb y i n s u rers th at are cu rren tl y s o l ven t. As p arto f t h e NSI acq ui s i t i o n , M r. Kel l y o b t ai n edtwo ap p rai s al s o f NSIDE. OnM arch 3 1 , 2 0 0 3, Ho u li h an , Lo k ey , Ho w ard& Zu k i n , In c., p rep aredan
an al y s i s o f NSI-DE’ s v al u e wh i ch d et erm i n edthatas o f t he d at e o f t he rep ortNSIDE’ s as set s ex ceed edi t s s t at edan dco nt i ng en t l iab i l i t ies an dco ncl u d edNSI-DE

“ s h o u l db e ab l e t o p ay

i t s d eb t s as th ey

b eco m e ab s ol u t e an dm atu re.” On J u n e 1 2 , 2 0 0 3 , J efferi es & Co
. , In c., i s s u edan an al y s i s o f NSI-DE’ s s o l v en cy an dl i k ewi s e
co n cl u d ed t h at NSI-DE’ s as s et s ex ceed ed i ts s t at edan di d en t i fi ab le co nt i n gen t- 2 0 -

[* 2 0 ] l i ab i l i t i es (wh i ch i n cl u dedth e as b es t o s cl ai m s ) an di t “ sh o u l db e ab l e t o p ay i t s d eb t s as th ey

m atu re.” Wh en th e NSI acq u i s i ti o n was co m pl et ed , NSI-DE h ado v er $ 1 b i l l io n i n i n s u ran ce co v erag e an d eq u i t y i n i t s as s et s , wh i ch wo u l dh av e b een s u ffi ci en tt o p ay i t s as b es t o s l i ab i l i t i es i n fu l l . Ith adv i rtu al l y n o d eb t b es i d es th e accru ed
as b es t o s l i ab i l i t i es . Ito wn edn u m ero u s p lan t s an d equi p m en t, free an d cl ear,
v al u edatro u g h ly

$ 1 50 m i l li o n . Aft er t h e NSI acq u is i ti o n , M r. Kel l y co n t i n u edt o
o p erat e Nat i on al Li n en an dAt lan t i c En v el op e. Ho wev er, i n 2 00 5 h e b eg an t o s el l
o ff d i v i s i o n s o f Nat i o n al Li n enan dco m p l et edth e s al e o f Nat i o n al Li n en i n 2 0 0 6 fo r a t o tal o f ro u g h l y $ 2 0 5 m i l l i o n . Al s o i n 2 00 6 , NSI s ol dAt l an t i c En v el op e fo r ap p ro x i m at el y $ 7 0 m i l l i o n . M r. Kel l y u s edth e s al e p ro ceed s, al o n g wi t h i n t eri m
o p erat i n g i n co m e an dcas hfl ow, t o fu l l y rep ay th e l o an s th ath e h ado b t ai n edt o fi nan ce t h e NSI acq u i s i t i on . Aft er rep aym en t o f t he l o an s , NSI-DE h adcas h o n h an d. Al th o ug h i tco n t i nu edt o h av e as b es t o s l i ab i l it i es , M r. Kel l y ex p ect edth em t o b e fu l l y

co v eredwi t h ex i s t i n g i n s u ran ce. Acco rd i n gl y , M r. Kel ly m ad e a d eci s i o n t o u s e NSI-DE as h i s qu as i -b an kt o fi n an ce h i s o th er b u s i n es s v en tu res . He h adap p ro ach edth e NSI acq u i si t i o n wi th the s am e b as i c p l an as h i s p ri or i n v es t m en t s , t o s t ri p cas h fro m NSI-DE p ri m ari l y t h ro u g h l o an s t o h i s o th er b u s i n es s v en tu res s etup as s ep arat e co m pan i es . He b el i ev edth e cas h av ai lab l e i n- 2 1 -

[* 2 1 ] NSI-DE was b as i cal l y h i s m o ney

th at co ul db e l en t t o h i s affi l i at ed
co m p an i es . He u s ed b o t h NSI-DE an dNSI-CA t o tran s fer fu n ds t o h i s affi l i at ed
co m p an i es . NSI-DE h adu ni n s u redas b es t o s l i ab il i ti es an d t h e n eed t o ret ai n cas h
res erv es o n i t s b al an ce s h eet s as a s o u rce t o fu n dp aym en to f as b es t o s cl ai m s . Acco rd in g ly , M r. Kel l y

reco rd edthe t ran s fers fro m NSI t o h i s affi l i at edco m p an i es
as l o an s as a t o o l t o k eep NSI-DE’ s b al an ce s h eets t at i c, t hereb y p aci fy i n g
as b es t o s p l ai n t i ff l awy ers , wh i le p u t ti n g t h e cas h t o wo rkan dearn i ng retu rn s fro m i n v es t i n g i n o t h er d eal s . III. In t erco m

p an y Tran s fers It w as aft er co m

p l et i n g th e NSI acq ui s i t i o n th atM r. Kel l y d eci dedt o
o rg an i ze Kel ly

Cap i t al t o en g ag e i n i n v es t m en t act i v i t i es wi t h ou th is b ro t h er an d b eg ant o co n du ctm o s t o f h i s b u s i nes s v en tu res th ro ug h Kel ly Cap i t al
. M r. Sp ri g g s s erv edas ex ecu ti v e v i ce p res i d en t an d l at er as p res i d en t . Atth e t i m e o f th e NSI acq u i s i t i on , NSI-DE h adi t s o wnacco un t i n g d ep art m en t, an di t s
acco u n t in g reco rd s i n i ti al l y co n t i n u edt o b e co n t ro l ledb y i t s o wnacco u n ti n g s t aff
an d CFO. Ats o m e p o i n t , th e acco u n t i n g reco rd s an dres p o n si b i l i t i es were tran s ferred t o Kel ly

Cap i t al
.- 2 2 -

[* 2 2 ] Du ri n g 2 0 0 4 th o u g h 2 0 07 M r. Kel l y o rg an i zedth ree m o re en t i t i es as p arto f h i s b u s i n es s i n v es t m en tact i v i ti es . InJ u l y 2 0 0 4 h e o rg an i zedFSIF wi t h M r. Sp ri g g s . Kel l y

Cap i tal i n it i al l y

o wn ed9 5 % o f FSIF, an dM r. Sp ri g g s o wn ed5 %. FSIF was o rg an i zedaft er q u es t i o n s were rai s edab o u t a $ 2 3 .8 m i l l i o n tran s fer fro m NSI-DE t o FCC. As a res u lto f t h es e qu es t i o n s th e t ran s fer was reco rd edas a tran s fer fro m

NSI-DE t o FSIF an dth en fro m FSIF t o FCC. NSI-DE t ran s ferred ad d it i o n al am o u n ts t o FSIF du ri n g 2 0 0 5 an dFSIF rep ai dap p ro x i m at el y $ 6 .2
m i l l io n du ri n g 2 0 0 6. As o f t h e en do f 2 0 0 6 th ere was an o u t s t an d i n g b al an ce i n NSI-DE’ s b o o k s an d reco rd s o f at l eas t$ 3 3 .7 m i l l i o n du e fro m FSIF. On J u n e 2 5 , 2 0 0 7 M r. Sp ri g g s s ol dh is 5 % i n t eres ti n FSIF t o Kel l y Cap it al an dKel ly

Cap i t al b ecam e FSIF’ s s o l e m em b er. OnAu gu s t2 8 , 2 0 0 5, M r. Kel ly o rg an izedKel l y Cap i t al In v es t m en ts , LLC (Kel l y In v es t m en t s ), wi t h Kel l y Cap i t al as i t s s o l e m em

ber. Aro u ndth at t i m e M r. Kel l y b eg an t o t ran s fer fu n ds fro m NSI-DE an dNSI-CA t o Kel l y Cap i t al an d Kel l y In v es t m en t s i n st eado f FCC. On M ay 3 0 , 2 00 6 , M r. Kel l y

o rg an i zedKel l y Fi n an ce, LLC (Kel l y

Fi n an ce), wi th Kel l y

Cap i t al as i t s s o le m em

b er. Kel ly Fi n an ce’ s b u si n es s act iv i t y was m i n i m al , an di t s ex i s t en ce t erm i nat edi n J ul y 2 0 0 9. Bet ween 2 0 0 4 an dM arch 2 0 1 1 NSI t ran s ferred ap p ro x i m at el y $ 1 75 m i l l i o n t o M r. Kel l y

an dh i s affi l i at edco m

p an i es thatNSI ch aract eri zedas l o an s i n i t s- 2 3 -

[* 2 3 ] b o o k s an d reco rd s . Du ri n g 2 0 0 4 th ro u g h 2 0 06 NSI t ran s ferred ap p ro x i m at el y $ 5 7
. 2 m i ll i o n t o M r. Kel l y an d h i s affi l i at edco m

p an i es i n cl u d i n g th e $ 3 3.7 m i l l i o n th atwas reco rd edas l o an s t o FSIF as o f t h e en do f 2 0 0 6 . Fro m 2 0 0 7 t o 2 0 1 0 NSI t ran sferred ap p ro x i m at el y $ 1 0 0 m i l l i o n t o Kel l y

Cap i t al an d Kel l y In v es t m en t s wh ich NSI ch aract eri zedas l o an s as fo ll o ws : 4

Year Bo rro wer Am o u nt 2 0 0 7 Kel l y

Cap i t al $ 41 ,2 3 0 ,0 0 0 2 0 0 8 Kel l y

Cap i t al 21 ,5 3 7 , 2 5 9 Kel l y In v es t m en ts 17 ,5 3 6 , 4 8 6 2 0 0 9 Kel l y

Cap i t al 17 ,0 8 9 , 9 9 6 2 0 1 0 Kel l y

Cap it al 3 ,4 5 1 , 6 9 6 Kel l y Cap i t al an dKel l y

In v es t m en t s ex ecu t edp ro m i s s o ry n o t es fo r th e tran s fers fro m

NSI t h atp ro vi d edfo r i n t eres tatth e s h o rt -t erm Fed eral rat e o f i n t eres t . Th e accru edi n t eres t was track edi n NSI’ s reco rd s . M r. Kel l y d idn o t h av e i n t eres t ch arg edo r accru edo n l o an s b et ween h is s i n g l e-m em b er LLCs
. Du ri n g 2 0 0 7 Kel l y

Cap i t al rep ai dap pro x i m at el y $ 6
. 2 m i l li o n o f t h e t ran s fers
.

4 W e b as e o u r fi n d i n g s o n a t ab l e at t ach edt o res p on d en t ’ s b ri ef as M r. Kel l y h as co nced edo n b ri ef t hatth e am o u n ts o f t h e t ran s fers s etfo rt h i n th e t ab le are co rrect
.- 2 4 -

[* 2 4 ] Du ri n g 2 0 0 7 t h ro u g h 2 0 1 0 NSI al s o t ran sferred ap p ro xi m at el y $ 1 6
. 7 m i l l io n d i rect l y t o M r. Kel l y , wh i ch NSI reco rd edas l o an s . IV. Bu s i n es s Ven tures Aft er NSI Acq u i s it i o n A. Iv y Ho t el In M ay 20 0 2 M r. Kel l y

p u rch as eda h o t el ad

jacen tt o TBE’ s b ar wi t h th e p ro ceed s fro m

th e s al e o f J CE’ s real es t at e fo r $ 7 .8 m il li o n wi t h t h e i d ea o f
ren o v at i n g i ti n t o a b o u t i qu e h o t el kn o wn as th e Iv y Ho t el . Iv y

Ho t el , LLC, i n i t i al l y kn o wn as 6 3 0 F St reet , LLC (IHSD), was o rg an i zedt o o wnth e h o t el
. IHSD was wh o l l y

o wn edb y

J CE. M r. Kel l y

al s o acq u i redan ap art m en tb u i l d i n g wi th ret ai l s h o p s o n th e fi rs tfl o o r t h atwas ad jacen tt o TBE’ s b ar an dab u t t edth e h o t el . M r. Kel l y

o rg an i zed Gas l am

p Part ners as a s p eci al p u rp o se en t i ty t o o wn th e ap art m en t b u i ld i n g . M r. Kel l y t o re d o wnth e b u i l d i n g t o u s e th e l an das a p ark i n g l o tfo r t h e h o t el
. In M arch an dM ay

2 0 0 3 IHSD recei v ed o ffers t o b u y th e h o t el fo r $ 1 3 .7 5
m i l l io n , wh i ch wo u ldh av e res u l t edi n an ap p ro xi m at el y $ 5 .6 m i l l i o n p ro fi t . M r. Kel l y d ecl in edth es e o ffers b ecau s e h e b el i ev edth ath e co ul dren o vat e t he h o t el
an d s el l i tfo r a g reat er p ro fi t
. To fi n an ce th e ren o vat i o n s , M r. Kel l y o b t ai n eda $ 4 8 .5 m i l l i o n co n s t ru ct i o n l o an fro m Fo rt res s . OnDecem

b er 9 , 2 0 05 , IHSD (t og et h er wi th o th er en t it i es th atM r. Kel l y co nt ro l l edi n cl u d i n g Kel ly Ho s p i t al i t y )- 2 5 -

[* 2 5 ] en tered i n to a l o an an ds ecu ri t y ag reem en t wi t h Fo rt res s (IHSD co n st ru ct i o n l o an ). M r. Kel l y

an dRi ch ardp ers o n al l y

g u aran teedthe l o an . Th e l o an was
s ecu redb y

th e h ot el i t s el f an dJ CE, as wel l as o t h er p ro p ert i es o wn edb y M r. Kel l y
an d FCC. M r. Kel ly

em b ark edo n t h e co n s i derab l e p ro jecto f co m

p l et el y g u t t i n g
an d ren o v at i n g the 2 0,0 0 0 -s qu are-fo o tb u i l di n g . OnJ u n e 6 , 2 0 0 7 , IHSD t o g et h er wi th th e o t her o b l ig o rs o f t h e IHSD co n s t ru ct i o n l o an en tered i n t o an am en d m en t
o f t h e l o an an ds ecu ri t y ag reem en t t h ati n creas edth e m ax i m u m l o an am o u ntt o $ 6 5 m i l l i o n . M r. Kel l y

al s o u s edap p ro xi m at el y $ 4 4 m i l l i o n fro m

Kel ly Cap i t al fo r co n s tru ct i o n co st s . Wh en co n s t ru ct i o n o n th e h o t el fi ni s h edi n m i d -2 0 0 8 , th e n ew Iv y Ho t el
was a fo u r-s t o ry

h o tel wi t h a b as em en t b an qu et faci l i t y , m eet i n g ro o m s , an da
ro o ft op p o o l an db ar. Aft er co m p l et i o n M r. Kel l y

an dh is en t i t i es ran th e fo o dan d b ev erag e s erv i ces atth e Iv y Ho t el an dan o u t s i de m an ag em en t co m pan y ran th e h o t el o p erat io n s . Un fo rtu nat el y , the Iv y Ho t el s uffered wi t h fi nan ci al d i ffi cu l t i es qu i ck l y aft er co n s t ru ct i on was co m p l et ed . Inl at e 2 0 08 M r. Kel l y at t em p t edt o s el l th e n ewl y fi ni s h edh o t el . He i n i t i al l y ex p ect edt o s el l i tfo r $ 1 2 0 t o $ 1 30 m i l l i o n , b u to ffers s o o n dro p p ed t o $ 8 0 t o $ 9 0 m i l l i o n . In2 00 8 t he h o tel was ap p rai s edat ap p ro x i m at el y $ 8 7 m i l l i o n .- 2 6 -

[* 2 6 ] Faci ng fi n an ci al d i st res s wi t h co n ti n u edo wn ers h ip o f t h e Iv y Ho t el , M r. Kel l y ap p ro ach edFo rtres s t o ad dres s th e cru s hi n g d eb t . InNo v em ber 2 0 0 8 M r. Kel l y wro t e t o Fo rt res s wi t h an up d at e o f t h e Iv y Ho t el ’ s fi n an ci al s tatu s an dh i s i n ab i l i ty t o s el l th e h o t el . Fo rt res s p u tM r. Kel l y i n co n t actwi t h o t her b o u t i qu e h o t el o wn ers an d o p erat ors . Th es e co n t act s ev en tu al ly cu l m i n at edi n a p art n ers h i p wi th Hy at tHo tel s . As a res u l t , th e Iv y Ho tel ’ s n am e was ch an g edt o the An d az Ho t el . An d az Ho tel g uaran t eedIHSD’ s p aym en to bl i g at i o ns o n t he co n st ru ct i o n l o an fo r a p eri o dan dm ad e p aym en t s du ri ng th e y ears ati s su e. In Feb ru ary

2 0 1 0 IHSD an dKel l y

Ho s p i t al it y , wh ich was o n e o f t h e
o ri g i nal o b l i g o rs o n th e IHSD co n s t ru ct i o n l oan , en t eredi n t o a s eco n d am en d m en t
o f t h e IHSD co n s t ru ct i o n l o an wi t h Fo rt res s . As a co n d i t i o n p reced en t t o t h e
s eco n dam en dm en t , Fo rt res s req u i redth atIHSD p ro v i d e ad d i t i o n al co l l at eral . M r. Kel l y u s edv ari o u s p ro p ert i es o wn edb y h is affi l i at edco m p an i es an d h is p ers o n al
res i den ce as co l lat eral . Am o n g o t h er th in g s , th e s eco ndam en dm en ts p li t t h e
ex i s t in g $ 6 2 m i l l i o n i n t o t wo l oan s o f $ 5 0 m i l l i o n an d$ 1 2 m i l l i o n . M r. Kel l y an d Ri ch ard pers o n al l y

g uaran t eedth e t wo l o an s . Th e co n s t ru ct i o n l o an was
s ub s equ en t l y

am en d ed fi v e m o re t i m es , b u t ats o m e p o i n t Fo rt res s was n o l o n g er wi l l i ng t o am en do r t o l en dt o M r. Kel l y an dd em an d edh e s el l t h e h o t el . On M arch 4 , 2 0 1 3 , th e h ot el was s o l d fo r $ 5 3 m i l l io n , wh i ch was i n s u ffi ci en tt o fu l l y- 2 7 -

[* 2 7 ] rep ay

Fo rt res s . Wh en th e h o t el was s ol d , IHSD, Kel l y Ho s p i t al i t y , an d Fo rt res s am en d edth e t erm s o f t h e co n s t ru ct i o n l o an t o p ro v i d e fo r t h e rep aym en t
o f t h e rem ai ni ng l o anb al an ce an dth e rel eas e o f cert ai n co l l at eral . M r. Kel l y was req u i redt o s i g n a d efi ci en cy n o t e o f $ 6 t o $ 8 m i l l i o n , m ak i n g h i m p ers o n al l y l i ab l e fo r t hi s am o u n t
. In Feb ru ary

2 0 0 9 M r. Kel l y

co n vert edth e $ 4 4 m il l io n d eb tdu e fro m IHSD t o Kel l y Cap i t al i n t o an equ i ty

i n t eres ti n IHSD, an dIHSD was rel eas edfro m l i ab i l i ty on th e d eb t . Befo re t h att im e Kel l y Cap i t al h adn o o wn ers h i p i n t eres ti n IHSD. Aft er Feb ru ary

2 0 0 9 Kel l y

Cap i t al o wn ed8 1 .6 % o f IHSD an dJ CE o wn ed 1 8 .4 %. Aro u n d t h att i m e Ri ch ard ag reedt o redu ce h i s o wn ers h i p i n t eres ti n J CE i n ex ch an g e fo r t h e can cel l at io n o f d eb treco rd edas du e t o Kel l y Cap it al
. Du ri n g 2 0 0 9 thro u g h 2 0 1 1 M r. Kel l y o wn ed7 5% o f J CE an d Ri ch ardo wn ed2 5%. B. LBHo ri zo n s OnJ an u ary

2 0 , 2 0 0 5 , FSIF acq u i red LBHo ri zo n s fo r $ 4.5 m i l l io n an dth e
as s u m pt i o n o f LBHo ri zo n s ’ $ 2 .4 m i l l i o n b an kl o an . M r. Kel l y p ers o n al ly g u aran teedthe l oan . LBHo ri zo n s o wn edth ree real es t at e l o t s i n Ch arl o t t e Co u nt y , Fl o ri da, t h ati tp lan n edt o d ev el o p i n t o 1 5 co n d o m i n iu m u n it s (co n d o s ). LBHo ri zo n s en g ag eda g en eral co n t ract o r t o fi n i s h th e co n d o p ro ject an d o b t ai n ed a $ 1 4 .4 m i l l i o n co n s tru ct i on l o an th atM r. Kel ly p ers o n al l y

g u aran t eed
. M r. Kel l y- 2 8 -

[* 2 8 ] al s o tran s ferredfu n d s t o LBHo ri zo ns fro m h i s affi l i at edco m

pan i es , an das
o f Decem b er 3 1 , 2 0 1 0 , LBHo ri zo ns h ada b al an ce o f $ 6 , 4 1 8 ,8 5 2 du e t o M r. Kel l y ’ s affi l i at edco m

p an ies an d$ 2 5 ,0 0 0 du e t o FCC. M r. Kel l y rep o rt edth es e d eb ts as d i s ch arg ed i n 2 0 1 0
. In 2 0 0 8 , 2 0 0 9 , an d 2 0 10 LBHo ri zo n s s o l dth ree, fi v e, an ds ev en co nd o s , res p ect i vel y . Fo r 2 0 10 M r. Kel l y rep o rt edco s to f g o o d s s o l db y LBHo ri zo n s rel at i n g t o co n s t ru ct i o n co s t s fo r t h e co n d os o f $ 5 ,0 0 4,2 0 0 , wh i ch res p on d en th as
co n ced edi s al l o w ab l e. He al s o d educt edan i n t eres tex p en s e o f $ 1 5 6 ,4 0 5 , wh i ch
res p o n d en t d i s al l owedi n i t s en t i ret y , an dl i cen ses an dt ax es o f $ 1 1 , 3 8 6 an do t h er
ex p en s es o f $ 33 , 5 7 7 , o f wh i ch res p o n d en td i s al l o wed$ 5 3,3 1 4 an d$ 1 9 ,9 4 3 , res p ect i vel y . C. Vi rtu co n Ono r aro u n dAp ri l 1 9 , 2 0 0 4 , Vi rtuco n was o rg an i zedas a s i n g l e-m em b er LLC t o acq u i re an ai rp l an e. M r. Kel l y was th e s o l e m em

b er o f Vi rtu co n du ri n g th e y ears ati s s u e. OnM ay 6 , 2 0 0 4 , Vi rtu co n p u rch as eda 1 9 8 8 Gu lfs t ream Aero s p ace GIV ai rp l an e an dm ad e i m p ro v em en ts fo r a t o t al co s to f ap p ro x i m at el y $ 1 2 .3 m i l l i o n , fi n an ci n g th e p u rch as e wi t h a b an kl o an . NSI-DE an dM r. Kel l y g u aran teedthe l oan . Vi rtu co n al s o p ai d $ 1 2 5 ,0 0 0 i n b ro ker’ s fees an d $ 1 6 ,2 2 5 i n t i tl e i n s u ran ce as p arto f t h e p u rch as e. M r. Kel l y p u rch as edth e ai rp l an e t o al l o w- 2 9 -

[* 2 9 ] h i m an d o t h ers t o m o re effi ci en t l y v i s i tAt l an t i c En v el o p e’ s an d Nat i o n al Li n en ’ s m an u fact u ri n g p l an t s . M r. Kel ly al s o u s edth e ai rp l an e fo r p ers o n al p u rp os es , an dh e was n o tch arg edfo r h i s p ers o n al u s e, o n t h e b as i s o f a d eci s i o n b y h i s acco u n t in g s t aff. So m et i m e i n 2 0 0 7 M r. Kel l y d eci d edt o ch art er t he ai rp lan e t o rep ay th e acq u is i t io n l o an . Bo b Freem an , Vi rtu co n ’ s ch i ef p i l o t , wo rk edwi t h b ro k ers t o fi ndp o t en t i al cu s t o m ers . OnJ u n e 2 3 , 2 0 0 8, Vi rtu co n , M r. Kel l y , th e M ich ael R. Kel l y Tru s t (M RK Tru s t), NSI-DE, an dFCC en t eredi n t o a l o an ag reem en twi t h Ban k o f Am eri ca t o refi n an ce t h e o ri g i n al p u rch as e l o an fo r $ 1 5 ,1 2 6 ,6 40 , an d Vi rtuco n ex ecu t ed a p ro m i s s ory n o t e (Ban ko f Am eri ca l oan ). M r. Kel l y , th e M RK Tru s t , an dNSI-DE g u aran t eedth e d eb ti n cl u d i n g v ari o u s m o d i fi cat i o n s an d fo rb earan ce ag reem en t s rel at edt o th e s ecu ri t y ag reem en t
. As o f Decem

ber 3 1 , 2 0 0 8 an d2 00 9 , th e o u t s t an di n g b al an ce o n th e Ban k o f Am eri ca l o an was atl eas t t h e i n i t i al p ri n ci p al am o u n t , $ 1 5 ,1 2 6 ,6 4 0
. In2 0 1 0 Ban k
o f Am eri ca req u es t edth atM r. Kel l y s el l o r s u rren d er p o s s es s io n o f th e ai rp l an e. Ono r aro u n dOct o b er 1 , 2 0 1 0 , Ban ko f Am eri ca, M r. Kel ly , FCC, an dNSI-DE
en t eredi n t o a l o an m od i fi cat i o n ag reem en t i n wh i ch th e b o rro wers (i n cl ud i n g M r. Kel l y ) ag reed th atthe o ut s t an d i n g l o an was $ 15 ,8 2 5 ,7 00 , wh i ch (wi t h ro u n d i n g )
co n si s t edo f $ 1 4 ,7 1 0 , 3 2 9 o f p ri n ci p al , $ 9 2 1 ,6 2 4 o f accru ed an du np ai d i nt eres t ,- 3 0 -

[* 3 0 ] an d $ 1 93 ,7 46 o f u np ai d l at e ch arg es . M r. Kel l y p ers o n al ly

g uaran t eedth e l o an m o d i fi cat i o n . Vi rtu co n l at er s u rren d eredp o s s es s io n o f th e ai rp l an e t o Ban k
o f Am eri ca i n p art i al s at i s fact i o n o f t h e l o ani n t h e am o u n to f $ 7 .5 m il l io n , redu ci n g Vi rtu co n ’ s i n d eb t ed n es s t o $ 8 .8 m il l i o n . OnJ an u ary 9 , 2 0 1 2 , Vi rtu co n
an d Ban ko f Am eri ca en t eredi n t o a m u tu al rel eas e an ds et t l em en tag reem en t . In Ap ri l 2 0 12 Vi rtu co n’ s ex is t en ce t erm i n at ed
. OnSch edu l e C fi l edfo r Vi rtu co n fo r 2 0 10 M r. Kel l y d edu ct edi n teres t
ex p en s es o f $ 1,6 5 6 ,5 9 6 fo r am o u n t s th atwere p ai dt o Ban ko f Am eri ca. Res po n d en td et erm i n edth atVi rtu co n p ai d $ 2 7 2 ,0 2 0 t o Ban k o f Am eri ca as i n t eres tan dd i s al l o wedth e rem ai n d er. Du ri n g 2 0 1 0 Vi rtuco n h adrecei v ed tran s fers fro m

M r. Kel l y ’ s affi l i at edco m p an i es o f ap p ro xi m at el y

$ 2 .8 m i l l i o n . D. KY&C Ono r aro u n dFeb ru ary

2 1 , 2 0 0 8 , KY&C was o rg an i zed as a Caym an Is l an ds co rp o rat i o n t o acq u ire a Cay m an Is lan d s -fl ag g ed y ach t fro m a d i s t res s ed
s el l er fo r ro u g h l y

h al f o f i t s o ri g i n al p u rch as e p ri ce. In M arch 2 0 0 8 KY&C p u rch as edth e 1 3 1 -fo o ty ach t fo r ap p ro xi m at el y $ 9 .4 m i l l i o n n am i n g th e y ach tM Y Brazi l . To fu n d t h e p u rch as e, KY&C o b t ai n edan $ 8 .1 m il l io n b an kl o an fro m W el l s Farg o . M r. Kel l y

an dKel l y

Cap i t al g u aran t eedth e l o an . M r. Kel l y p ai dth e
rem ai n d er o f t h e p u rch as e p ri ce. M r. Kel ly co m p l et el y refi t tedth e v es s el wi t h th e- 3 1 -

[* 3 1 ] ex pect at io n o f s el li n g o r ch art eri n g i t. InAp ri l 2 0 0 8 KY&C co n t ract edfo r
m an ag em en ts erv ices fo r t h e y ach t, o bt ai n eda Fed eral em p lo y er i d en t i fi cat i o n
n u m b er, an dreg i s t eredt o t ran s actb u s i n es s i n Cal i fo rn i a. W i t h n o p ro s p ect iv e b u y er M r. Kel l y d eci d edt o ch art er M Y Brazi l , i n i t i al l y i n Eu ro p e. On M arch 1 1 , 2 0 0 9, KY&C en g ag eda ch art er m ark et i ng s erv i ce an d
s h i p p ed th e y ach tt o It al y wh ere i ts at u n t i l a ro g u e wav e s m as h edi ti n t o an ad jacen tv es sel . Li t i g at io n an di n su ran ce d is pu t es p rev en t edM Y Brazi l fro m
u n d o ck i n g . Un fo rtu nat el y , the ch art er s eas o n h aden d edb efo re i t was al l o w edt o
u n d o ck . M r. Kel l y retu rn ed MY Brazi l t o Fl o ri d a an dat t em p t edt o wo rko u tth e l o an wi th the l en d er. KY&C d i d n o t m ak e an y p aym en t s o n th e l o an . As o f Sep t em b er 2 2 , 2 0 1 0 , th e l o an b al an ce was th e o ri g i n al p ri n ci p al , $ 8 .1 m i l l i o n , p l u s i nt eres t
. InM ay 2 0 1 0 KY&C recei v edan o ffer t o p u rch as e th e y ach t fo r $ 8 m il l i o n an d i n earl y 2 0 1 1 recei v edtwo ad d i t io n al o ffers o f $ 6 m il li o n an d$ 5 .3 m il l i o n . M r. Kel l y d ecl i nedth es e o ffers . On Feb ru ary 2 2, 2 01 1 , W el l s Farg o t oo k p o s s es si o n o f t h e y ach tan do n No v em

ber 2 3 , 2 0 1 1 , s o l di tfo r $ 3 .3 m i l l i o n . Aro u n dthatt i m e, KY&C, Kel l y

Cap i t al , an dM r. Kel l y

en tered i nt o a d efi ci en cy ag reem en t wi t h W el l s Farg o (2 0 1 1 d efi ci en cy ag reem en t), wh erei n t h e p art i es ag reedth at as o f J an u ary 3 1 , 2 0 1 1, t he l o anb al an ce was $ 8 ,3 7 4 , 4 75 , co m pri s i n g ap p ro x im at el y- 3 2 -

[* 3 2 ] $ 8 .1 m il l i o n i n o u ts t an d i n g p ri n ci pal , $ 2 7 2,8 6 3 i n u np ai d i n t eres t , an d $ 1 ,6 1 2 i n l at e ch arg es . In cl u d edi n t h e 2 0 1 1 d efi ci en cy ag reem en twas an ag reem en t th at W el l s Farg o co ul d p ay

p ro t ect i v e ad van ces t o m ai n tai n M Y Brazi l . Itp ro v i d ed : Len d er m ay

p ay s u ch am o u n t s as Len d er i n i t s s ol e d i s cret io n d eem s ap p ro p ri at e fo r t h e p ro t ect i o n an d m ai n ten an ce o f t h e Pro p erty i n cl u d i n g , wi t h o u tl i m i t at i o n , p aym en to f t h e crew an d cap t ai n em p l o y edo n the Ves s el , p aym en t o f v en d ors an ds upp l i ers , p aym en t o f m ai nt en an ce an drep ai r co s t s , p aym en t s o f i ns u ran ce p rem iu m s , u t i l i t y s erv i ces , t ax es , du t i es , t ari ffs , an dal l o t h er fees an dco s ts an d al l o t h er fees an dco s t s the Len d er d eem s n eces s ary fo r t h e p ro tect i o n , m ai n t en an ce an d ri g h t fu l o wn ers h i p o f t h e Pro p ert y . An y am o un t s s o p ai d s hal l b e d eem ed“ Pro t ect i v e Ad v an ces ” an ds h al l b e s ecu redb y th e Secu ri t y

Do cu m en ts an di n cl ud edi n t he To t al Am o u n tDu e as d efi n edi n Sect i o n 1 o f thi s Ag reem en t
. Th e 2 0 1 1 d efi ci en cy ag reem en tfu rt her p ro v i d edth atKY&C, Kel l y Cap i t al , an d M r. Kel l y were o b l i gat edt o “ fi rs trep ay (i ) t h e In i t i al Pro t ect i ve Ad van ces an d (i i) an y Cu rren tTax es p ai db y

th e Len d er, wi t h o u td i s co u n t an dwi t h o ut ap p li cat io n o f an y

p ro ceed s fro m

th e s al e o f t h e Pro p ert y .” KY&C, Kel l y Cap i t al , an d M r. Kel l y d i dn o tm ak e an y p aym en t s u n d er t h e 2 0 1 1 d efi ci en cy ag reem en t
an d o n Oct o b er 1 , 2 0 1 4 , en t eredi n t o an am en d edan dres t at edd efi ci en cy ag reem en t . Th e am o u nt s o wedu n d er t h i s ag reem en twere p ai di n fu l l
. M r. Kel l y ’ s s o le o wn ers h i p o f KY&C ren d eredi ta co n t ro l l edfo rei g n
co rp o rat i o n s ub

jectt o th e rep o rt i n g req ui rem en t s o f s ect i o n 6 03 8 . No Fo rm 5 4 7 1- 3 3 -

[* 3 3 ] was t i m el y

fi l edfo r KY&C fo r t ax y ear 2 0 0 8 o r 2 00 9 . InOct o b er 2 0 1 9
res p o n d en t i n fo rm edM r. Kel l y ab ou tth e m i s s i ng Fo rm s 5 4 7 1, an d M r. Kel l y fi l ed th e fo rm s s h o rt l y

th ereaft er. Onth e Sch edu l es C fi l edfo r KY&C fo r 2 0 1 0 an d2 0 1 1 M r. Kel l y d edu ct ed
ex p en s es th atwere p ai d wi t h b o rro wedfu n d s . Fo r 2 0 1 0 h e d edu ct ed$ 7 8 2,5 4 2 i n
ex p en s es , an dres po n d en td i s al l o w ed$ 1 4 3 , 7 4 6 o f t h e d edu ct io n s i n cl ud i n g $ 2 1 ,8 4 4 d edu ct edfo r car an d t ru ckex p en ses . Fo r 2 0 1 1 h e d edu ct ed$ 2 9 8,4 4 2 i n
ex p en s es an d $ 1 1 1 , 5 9 1 fo r d ep reci at i on , an d res po n den t d i sal l owedal l b u t $ 2 ,0 5 4
o f t h e ex p en s e d edu ct i o ns an dd i s al l o wed$ 2 7 , 8 7 4 o f t h e d ep reci at i o n d educt i o n . V. Fai l u re o f Bu s i n es s es By 2 0 0 8 M r. Kel l y fo u n di td i ffi cu l tt o p ay h i s cred i t o rs . He wan t edt o
av o idb an krup t cy b u tfo un di t i m p o ss i b l e t o p ay

th i rd -p art y

d eb ti n cl u d i n g l o an s
m ad e b y Fo rt res s . Atth e en do f 2 0 07 h e s t art ed t o reduce d eb to w edb et ween h i s affi l i at edco m

p an i es b y wri t i ng o ff d eb t due t o FCC. He al s o redu cedth e d eb t du e t o NSI-DE b y

d ecl ari n g d iv i d en d s an d d i s t ri b u t i n g t h e d eb t t o the s h areh o l d ers . By 2 00 8 th e recap i tal i zat io n o f NSI was u n real i s t i c. M r. Al o n s o , Kel l y Cap i t al ’ s g en eral co u n s el , d i s cu s s edfi li n g b an krup t cy wi t h M r. Kel l y i n 2 0 0 8 . M r. Kel l y ’ s b u s i n es s v en tu res s uch as th e Iv y Ho t el were fai li n g an d d i dn o tp ro v i d e a
reas on ab l e p ro s p ecto f rep ay in g th e ad v an ces fro m NSI. YetM r. Kel l y

co n t i n u ed- 3 4 -

[* 3 4 ] t o ad v an ce ap p ro x i m at el y $ 2 0 m i l l io n fro m

NSI t o Kel l y

Cap i t al du ri n g 2 0 0 9 an d2 0 1 0 . Th e s itu at i o n was m ad e wo rs e b y a s ubs equ en t$ 3 5 .7 m i l l i o n d efau l tju d g m en t en t eredag ai n s tNSI i n an as b es t os l aws u it i n M ay 2 0 1 1
. A. Wri t eo ff o f Deb tt o FCC As o f Decem

ber 3 1 , 2 0 0 7 , FCC’ s b o o k s refl ect edth atth ere was d eb tdu e fro m M r. Kel l y ’ s affi l i at edco m p an i es t o FCC o f $ 2 5 ,5 9 4 ,0 07 . Onth atd at e FCC
wro te o ff as b add eb t s am o u n t s du e fro m the affi l i at edco m

p an i es as fo l l o ws : En t i t y Am o u n t Hi d d en Hi l l s Ho l d i n g $ 3 ,8 8 3 ,5 6 7 Hi d d en Hi l l s Res o rt 4 ,4 62 ,4 4 6 Lu cky Bas t ardReco rd s 9 52 ,3 9 3 Twi n PeakPl aza 7 25 ,8 0 3 To t al 1 0 ,0 24 ,2 1 0 B. NSI Di v i d en ds o f Deb t In 2 0 0 7 an d2 0 0 8 NSI-DE d ecl aredthatth e s h areh o ld ers wo u l drecei v e d i v i d en d s o f t h e p u rp o rt edd eb t s du e t o NSI-DE fro m FSIF, Kel l y

Cap i t al , M r. Kel l y , an dM r. Sp ri g g s . Th e p aym en to f t h o s e d i v i d en d s m ean tth at FSIF, Kel l y Cap it al , M r. Kel l y , an d M r. Sp ri g g s n o l o n ger o wedth e d i vi d en d am o u nt s t o NSIDE an dNSI-CA. In st ead , the d eb t s were du e t o NSI-DE’ s s h areh o l d ers . OnJ u n e 2 5 , 2 0 0 7 , NSI d ecl areda d i v id en do f t h e FSIF d eb to f $ 3 1 ,1 3 1 ,2 84 (2 0 0 7- 3 5 -

[* 3 5 ] d i v i d en d ), wh i ch was al l o cat ed9 5 % t o Kel l y Cap it al ($ 2 9,5 7 4 ,3 0 7 ) an d5 % t o M r. Sp ri g gs ($ 1,5 5 6,5 6 4 ). Acco rd i n g t o th e 2 0 0 7 d i v id en d i n k i n d , FSIF n o l o n g er o wed t h e d i v i d en d am o un tt o NSI an d i n s t eado wedi tt o Kel l y Cap i t al an d M r. Sp ri g g s . OnDecem

b er 3 1, 2 00 8 , NSI d ecl areda d i v i d en do f $ 4 0 ,1 9 7 ,8 9 5 (2 0 0 8 d i v i d en d ) th atwas al lo cat ed9 5 % t o Kel l y Cap i t al an d5 % t o M r. Sp ri g g s . Kel l y Cap it al recei v eda d i vi d en d o f d eb tdu e fro m M r. Kel l y

t o NSI-DE o f $ 24 .5
m i l l io n p l u s i n t eres t o f $ 2 , 1 6 1 , 4 1 9 fo r a t o t al o f $ 2 6 ,6 6 1,4 1 9 an da d eb tdu e fro m Kel l y Cap i t al o f $ 9 ,7 03 ,8 76 p lu s i n t eres tfo r a t o t al o f $ 11 ,4 5 9 , 0 81 . M r. Sp ri g g s recei v eda d i v id en dfo r t h atam o u n tth ath e h ad du e t o NSI o f $ 1 , 8 1 3 ,7 4 7 p l u s i n t eres t . Acco rd i n g t o t h e 2 0 0 8 d i v i d en di n k i n d , th e $ 2 6 ,6 6 1 ,4 1 9 d eb t was du e fro m M r. Kel l y to Kel ly

Cap i t al an dKel l y Cap i t al n o l o ng er o wedth e $ 1 1 ,4 5 9 ,0 8 1 d eb t t o NSI-DE. Oni ts b oo k s an dreco rd s NSI-DE treat edth e d i v id en do f t h e $ 1 1 ,4 5 9 ,0 8 1 d eb t du e fro m Kel l y Cap i t al as a s h areh o l d er d i s t ri b u t i o n an dredu ced th e am o un tdu e fro m Kel l y Cap i t al b y

$ 1 1 ,4 5 9 ,0 81 . Acco rd i n g t o t h e 2 00 8 d i v i d en d i n k i n d , M r. Sp ri g g s n o l o n g er o wed$ 1 ,8 1 3 , 7 47 p l u s i n t eres tt o NSI-DE. Du ri n g 2 0 0 8 NSI-CA al s o tran s ferreds t ocki n two u n rel at edco m p an i es , IM PAC an dFreem o n t , t o Kel l y In v es tm en t s . NSI-CA i n i t ial l y reco rd ed t h e- 3 6 -

[* 3 6 ] tran s fer o f t h e Freem on ts t o ckas a $ 1 .8 m i l l i o n d eb tdu e fro m Kel l y In v es t m en t s b u tl at er i n creas edth e am o u n tt o $ 8
. 1 m i ll i on . C. Sep arat io n o f Bro t h ers ’ Bu s in es s es Du ri n g th e 2 00 8 reces s i o n M r. Kel l y an d Ri ch ard d eci dedt o s ep arat e t h ei r b u s i n es s affai rs . Kel l y

Cap i t al h ad t ran s ferred s ub s t an t i al am o u n t s o f m o n ey t o Ri ch ard in cl ud i n g ap p ro x im at el y $ 3 .5 m il l i o n i n b ot h 2 00 7 an d2 00 8 an dan ad d it i o n al $ 8 0 0,0 0 0 i n 2 0 0 9 . Ri ch ardu s edth es e fu n d s t o p ay p ers on al ex p en s es . As o f M ay

2 0 0 9 h e h ada b al an ce du e t o Kel l y Cap i t al o f $ 1 ,8 7 1 , 5 1 8 an dTBE h ad a b al an ce du e o f $ 3 0 9 ,5 29 . Inth e p ro ces s o f s ep arat i n g M r. Kel ly an d Ri ch ard ’ s b u s i n es s es , Kel l y

Cap i t al ag reedt o can cel th es e d eb t s as p arto f an ex ch an ge ag reem en td at edM ay

1 1 , 2 0 0 9 . Th e b ro t hers al so res t ru cturedth ei r o wn ers h i p i n t eres t s i n v ari o u s b us i n es s es th atth ey jo i n t l y o wn edi n cl u d i n g J CE, TBE, an d
o n e o ther en t i t y

n o t rel ev an th ere. Th ey

wen t fro m

equ al o wn ers o f J CE t o M r. Kel l y ’ s o wn i n g a 7 5% i n t eres t an dRi ch ard ’ s o wn in g 2 5%. Fo r TBE, o f wh i ch M r. Kel l y an d Ri ch ardh ad o wn ed5 1 % an d4 9 % , res p ect i v el y , Ri ch ard ’ s i nt eres t i n creas edt o 7 7 .6 %, M r. Kel l y ’ s i n t eres td ecreas edt o 1 8 .2 %, an dth ree o t h er i n d i v i du al s recei v ed t h e rem ai ni n g i n t eres t
.- 3 7 -

[* 3 7 ] D. 2 01 0 Di s ch arg e o f Deb t In M arch 2 01 0 M r. Kel l y d i s p o s edo f h i s i n t eres t i n Rad i u s M o rt g ag e. So m et im e i n l at e 2 0 1 0 o r earl y 2 0 1 1 M r. Kel l y

h ada m eet i n g wi t h h i s l eg al , t ax , an d acco un t in g ad v is ers , i n cl u d i n g M r. Th o m as , M r. Bo wen , an dM r. M ark s , wh o ad v is edM r. Kel l y

th ath e was i n s o l v en t . M r. Kel l y wan t edt o av o i db an krup t cy b u tfo u n di ti m

p o ss i b l e t o rep ay

th ird -p art y

l o an s du e t o Fo rt res s an dHo m e Sav in g s & Lo anCo . (Ho m e Sav i n g s ). OnDecem b er 3 0 , 2 01 0 , M r. Kel l y

rem o v ed M r. Sp ri g g s fro m

NSI-DE’ s b o ardo f d i rect o rs an del ect edh i m s el f t he s o l e d i rect o r. Th e n ex td ay , as th e s o l e d i rect o r o f t h e b o ard , M r. Kel l y d eci d edt o wri t e o ff d eb t s o f $ 6 3,9 1 0,3 1 0 an d$ 1 4 ,9 1 6 , 5 96 du e fro m Kel l y Cap i t al an dKel l y In v es t m en t s , res p ect i v el y . Th es e d eb t s were due t o b o t h NSI-DE an d NSI-CA. Fo r t h e 2 0 1 0 t ax y ear M r. Kel ly wro t e o ff d eb t du e t o an d fro m h i s affi l i at ed
co m p an i es an dcl ai m eds h o rt -t erm cap i t al l o s s es fo r t h e d i sch arg edd eb t
. Onh i s 2 0 1 0 p ers o n al retu rn M r. Kel l y rep o rt edb add eb t wri t eo ffs o f $ 8 6 ,9 7 9 ,9 5 6 as s h o rt -t erm cap i t al l o s s es fro m

h i s s i n g l e-m em

ber LLCs as fo l l o ws : $ 7 2 ,9 6 8 ,6 7 6 fro m

Kel l y Cap i t al , $ 9,6 7 2 ,3 0 1 fro m Kel ly In v es t m en t s , $ 4 , 1 2 7 ,7 5 0 fro m FSIF, $ 2 4 ,9 7 2 fro m

Kel l y Ho s p i t al i t y , an d $ 1 8 6 ,2 5 7 du e fro m Vi rtu co n . Of th e $ 7 2,9 6 8 ,6 7 6 wri t t en o ff b y Kel l y Cap i t al M r. Kel ly

p ers o n al l y

o wed$ 2 5 .8
m i l l io n an dth e rem ai n d er was o wedb y M r. Kel ly ’ s affi l i at ed co m p an i es : $ 2- 3 8 -

[* 3 8 ] m il l i o n du e fro m

Green b ackEn t ert ai n m en t , $ 4 .7 m i l l i o n fro m Green b ack Ho l di n g s , $ 1 7.9 m i l l i o n fro m FCC, $ 1 .5 m i l l i o n fro m

Lem en Ro adPro p ert i es , LLC (Lem en Ro ad ), $ 7.2 m i l l i o n fro m Kel l y M OB1 , LLC (M OB1 ), $ 2 .7 m i l l i o n fro m Vi rtu co n , $ 4.3 m i l li o n fro m KY&C, an d$ 6.4 m i l l i o n fro m LBHo ri zo n s . M r. Kel l y al s o rep o rt ed$ 1 ,8 5 4 ,9 0 5 o f s h o rt -t erm cap i tal l o ss es th ath ad p as s edth ro u g h fro m

the b add eb t s o f NSI-DE, J CE, IHSD, FCC, an dGreen b ack En t ert ai nm en t as s etfo rt h i n m o re d et ai l b el o w. He cal cu lat edl o s s es fro m th e wri t eo ff o f t h e t o t al b add eb ts du e t o t h es e fi v e en t i t i es o f ap p ro x i m at el y $ 9 1 .4
m i l l io n an dcl ai m edth e redu cedam ou n t as a l o s s d edu ct io n o n th e b as i s o f l o s s l i m i tat i on s . He redu cedt ax at tri b u t es o f t h es e en t i t ies an dcarri edfo rward ed $ 5 7 ,6 5 0 ,9 9 5 o f t h e l o s s es . Int o t al , h e rep o rt ed n ets h o rt -t erm cap i t al l o s ses o f $ 8 8 ,8 3 4 ,8 6 1 . He al s o rep o rt edn etl o n g-t erm cap i tal g ai n o f $ 7 ,5 54 ,2 5 5
. NSI wro t e o ff d eb t o f $ 6 3 ,9 1 0 ,3 1 0 an d$ 14 ,9 1 6 , 5 9 6 du e fro m Kel l y Cap i tal
an d Kel l y In v es t m en t s , res p ect i v el y , an dcl ai m eda $ 7 8 , 8 2 6 ,9 0 6 s ho rt -t erm cap i t al l o s s fo r “ BAD DEBT W RITE OFF” o n i t s 2 0 1 0 S co rp o rat i o n retu rn . As a 9 5 %
s h areh o ld er, Kel l y

Cap i t al was al l o cat ed$ 7 4 , 8 8 5 ,5 6 1 o f t h e l os s d educt i o n. NSI at t ach eda s t at em en tt o i t s 2 0 1 0 ret u rn s tat i n g th atKel l y Cap i t al an dKel l y In v es t m en t s were i n s ol v en t, as fo ll o w s :- 3 9 -

[* 3 9 ] NON-BUSINESS BAD DEBT: IN PREVIOUS YEARS NATIONAL SERVICE INDUSTRIES, INC. * * * ADVANCED KELLY CAPITAL, LLC * * * $ 6 3,9 1 0 ,3 1 0 AND KELLY INVESTM ENTS, LLC * * * $ 1 4 ,9 1 6 ,5 9 6 * * * FOR A TOTAL OF $ 7 8 ,8 26 , 9 0 6
. IT WAS DETERM INED THAT KELLY CAPITAL, LLC AND KELLY CAPITAL INVESTM ENTS, LLC W ERE INSOLVENT THEREFORE THIS AM OUNT W OULD NOT BE RECOVERED AND SHOULD BE WRITTEN OFF AS NON-BUSINESS BAD DEBT. FCC an dIHSD al s o rep ort eds h o rt -t erm cap i t al l o s ses fro m

th e wri t eo ff o f b ad d eb to f $ 5 , 6 0 3 , 3 9 3 an d$ 1 2 ,2 8 7 ,7 9 9 , res p ect i v el y , i n cl u d i n g d eb tdu e fro m Kel l y Cap i t al , Kel l y

In v es t m en t s , an dJ CE. Ho wev er, a s ubs t an ti al am o u n to f t h e d eb t th atFCC wro t e o ff, $ 4 .2 m i l l i o n , was du e fro m M r. Kel l y

p ers o n al l y . Onh i s 2 0 1 0 retu rn M r. Kel l y rep ort edth e d i s ch arg e o f d eb tdu e fro m h i s affi l i at edco m

p an i es an dat t ach edFo rm 9 8 2, Redu ct io n o f Tax At t ri bu t es Du e t o Di s ch arg e o f In d eb t ed nes s (an d Sect i o n 1 08 2 Bas i s Ad ju s t m en t ), rep o rt i n g a d i s ch arg e o f i nd eb t ed n es s o f $ 1 4 5 ,5 5 9 ,3 0 6 th atwas ex cl u d edfro m g ro s s i n co m e
o n th e b as i s o f h i s i n so l ven cy cal cu l at edas fo l lo ws : En t i t y Am o u nt Green b ackHo l d i n g s $2 ,6 0 5 , 5 8 6 J CE 3 ,7 9 3 , 4 3 7 IHSD 7 ,0 5 2 , 2 1 5 FCC 4 ,2 0 0 , 4 0 7- 4 0 - Kel ly Ho s p i t al i t y 3 ,0 2 7 , 8 2 9 KY&C 4 ,2 9 9 , 1 1 6 LBHo ri zo n s 6 ,4 1 8 , 8 5 2 Rad i u s M o rt g ag e 8 6 ,5 7 5 Kel ly In v es t m en t s 16 ,9 2 8 , 0 2 0 Lem en Ro ad 1 ,5 6 1 , 3 7 3 M OB1 7 ,1 6 1 , 3 6 3 Kel ly Cap i t al 85 ,7 4 3 , 0 3 1 Vi rtu co n 2 ,6 5 9 , 5 6 5 FSIF 2 1,9 3 7 In cl u d edi n t h i s cal cu l at io n i s th e d eb t due fro m Kel l y Cap i t al an d Kel l y In v es t m en t s o f ap p ro x i m at el y $ 6 3 .9 m i l li o n an d$ 1 4 .9 m i ll i on , res p ect i v el y , th at NSI wro t e o ff an d rep o rt edo n i t s 2 0 1 0 retu rn . Of the ab o v e cal cu l at i on o f COD i n co m e, o n l y

a s m al l p o rt i o n o f t h e d eb ti s u n rel at edt o tran s fers fro m NSI. Th e fo l l o w i n g d eb t was n o trel at edt o tran s fers fro m NSI: th e en t i re am o u n to wedb y Kel l y Ho s p i t al i t y

an dIHSD, $ 1 ,2 0 1 ,0 0 0 o f t h e Lem enRo add eb t , an d$ 3 ,7 9 3 ,4 3 7
o f t h e J CE d eb t
. M r. Kel ly al s o h adCOD i n co m e o f $ 4,0 11 ,8 5 1 fro m the d i s ch arg e o f d eb to wedt o thi rd -p art y l en der Ho m e Sav i n gs . OnDecem b er 2 3 , 2 0 1 0 , M r. Kel ly

an d h i s affi l i at edco m

p an i es en t eredi n t o an o m n i b u s fo rb earan ce ag reem en twi t h Ho m e Sav i ng s t h atd i s ch arg edd eb to f $ 4 ,0 1 1,8 5 1 . Acco rd i n g ly , [* 4 0 ]- 4 1 -

[* 4 1 ] M r. Kel l y h adCOD i n co m e fo r 2 0 10 u n rel at edt o tran s fers fro m NSI o f at l eas t $1 9 ,3 2 9 ,0 3 9
. In cl u d edi n t h e 2 0 1 0 d eb twri t eo ff was $ 7 ,1 6 1 ,3 6 3 du e fro m M OB1 . Atth e t i m e o f t h e wri t eo ff M OB1 o wn edan dl eas eda m ed i cal o ffi ce b u i l di n g . Th e
ren t al act i v i ty

was u np ro fi t ab l e du ri n g 2 0 0 9 an d 2 01 0 . Ho wev er, aft er t h e wri t eo ff M r. Kel l y s o l dri g h t s i n t h ree cel l t o wers o n th e b u i l di n g ’ s ro o f fo r $ 1 m i l l i o n an d th en s o l dth e b ui l d i n g i n a s ep arat e t ran sact i o n . FCC an dGreen b ack En t ert ai n m en tal so fi l edFo rm s 9 8 2 at t ach edt o t h ei r 2 0 1 0 retu rn s . FCC rep o rt edCOD i n co m e o f $ 2 1 ,1 7 5 ,9 3 3, i ncl u d in g $ 17 ,8 4 8 ,0 3 0 du e t o K el l y

Cap i t al , $ 2,1 2 7,7 5 0 du e t o FSIF, an dth e rem ai nd er du e t o fi v e o th er
co m p an i es . OnFo rm

9 8 2 FCC rep o rt ed$ 2 0 ,9 9 2,6 1 9 o f d i s ch arg edo f d eb t
ex cl u d edfro m

i t s g ro s s i n co m e o n the b as i s o f i t s i n s o l v en cy . FCC cl ai m eda
s h o rt -t erm

cap i t al l o ss d edu ct i o n o f $ 5 ,6 0 3 ,3 93 fo r t h e wri t eo ff o f b add eb tdu e fro m M r. Kel l y an dh i s affi l i at edco m p an i es i n cl u di n g $ 1 ,3 5 6 , 8 0 2 du e fro m J CE, $ 1 1 ,4 2 4 fro m

Kel l y In ves t m en t s , $ 3 3 ,5 1 6 fro m Kel ly Cap i t al $ 4 ,2 0 0 ,4 07 fro m M r. Kel l y , an dth e rem ai n i ng $ 1,2 4 3 fro m two o t h er en ti t i es n otrel ev an th ere. Oni t s 2 0 1 0 ret u rn Green b ackEn t ert ai n m en trep o rt eda s h o rt -t erm cap i t al l o s s o f $ 5 6 3 ,8 11 fro m

th e wri t eo ff o f a b add eb t fro m Green b ackHo l d i n gs . Green b ackEn t ert ai n m en t al so fi l eda Fo rm 9 8 2 at t ach ed t o i t s 2 0 10 retu rn- 4 2 -

[* 4 2 ] rep o rt in g t h e d i s ch arg e o f $ 2 , 0 1 4 ,0 6 1 o f d eb tdu e t o Kel l y Cap i t al
. Green b ackEn t ert ai n m en t rep o rt edth atth e d i s ch arg edd eb t was ex cl u d edfro m i t s g ro s s i n co m e o n th e b as is o f i t s i n s o l v en cy . Oni t s p art n ers h ip retu rn fo r 2 0 1 0 IHSD rep ort eds h o rt -t erm cap i t al l o s s es fo r “ BAD DEBT WRITE OFF” o f $ 1 2 ,2 8 7 ,7 9 9 an drep o rt ed COD i nco m e o f $ 8 ,6 4 0 ,3 0 3 , wh i ch i n cl u dedth e COD i n co m e fro m d i s ch arg edd eb to wedt o Fo rt res s . Th e COD i n co m e was al l o cat ed$ 7 ,0 5 2,2 15 t o Kel l y Cap i tal an d $ 1 ,5 8 8 ,0 8 8 t o J CE. E. NSI-DE’ s Ban krup t cy As o f M ay

9 , 2 0 1 0 , Kel l y

Cap i t al ’ s b o o k s s h o weda d eb t o f $ 5 0 0 ,0 0 0 du e fro m NSI-DE t o Kel l y Cap it al . Onth atd at e Kel l y Cap i t al p u rch as edNSI-CA fro m NSI-DE i n ex ch an g e fo r rel eas e fro m th e $ 5 00 ,0 0 0 d eb t . InJ u l y 2 01 2 NSIDE fi l eda v o l u n t ary

p et it i o n fo r ch ap t er 7 b an krup t cy t o wh i ch NSI-DE’ s b o ardo f d i rect o rs g av e i t s u n an i m ou s wri t t en co n s en t . Th erei n NSI-DE’ s b o ard o f d i rect o rs s t at edth at“ i t i s i n the b es t i n t eres t o f t h e Co m p an y , i t s cred i t o rs , an d
o th er i nt eres t edp art i es t o fi l e a v o l u n t ary p et i t i o n fo r rel i ef”. In i t s b an krup t cy p et i t i o n , NSI-DE rep o rt edas s et s o f l es s th an$ 3 00 ,0 0 0 an d l i ab i l i t i es o f ap p ro x i m at el y $ 5 5 m i l l i o n co ns i s t i n g p ri m ari l y o f u n s ecu redas b es to s cl ai m s wh i ch i n cl u d edth e $ 35 .7 m i l l i o n d efau l t ju d gm en t
.- 4 3 -

[* 4 3 ] OnJ u ne 4 , 2 0 14 , th e b an krup t cy t ru st ee co m m en cedan ad v ers ari al p ro ceed in g ag ai n stNSI, Kel l y Cap i t al , KCI, FSIF, NSI-CA/ En g l ewo o d , M r. Kel l y , an dM r. Sp ri g g s . OnNo v em ber 2 3 , 2 0 1 5 , M r. Kel l y

an dth e o t h er d efen d an t s fi l edan an s wer d en y i n g t h e t ru s t ee’ s al l eg at i o n s an d as s ert i n g d efen s es . OnJ an uary1 6 , 2 0 17 , th e p art i es t o th e b an krupt cy p ro ceed i n g fi l eda
m o ti o n t o ap p ro v e a co m p ro m i s e i n acco rd an ce wi t h a s et tl em en tag reem en tth at cal l edfo r a $ 3 .5 m i l l i o n s t i p u lat edju d g m en tag ai n s t M r. Kel ly . Th e m ot i o n t o ap p ro v e co m

pro m i s e was g ran t edo n Feb ru ary 1 0 , 2 0 1 7
. In 2 0 1 2 M r. Kel l y

o rg an i zedtwo n ew en ti ti es , Kel l y In v es t m en t Gro up , LLC, an dKC Adv i so rs , LLC. He m o v edal l o f Kel l y Cap i t al ’ s em

p l o y ees t o th es e
n ew en t i ti es . In2 0 1 3 K el l y Cap i t al ’ s ex i s t en ce t erm i n at ed
. VI. Pers on al Li fe OnAp ri l 1 8 , 2 0 0 6, M r. Kel l y m o v edfro m San Di eg o, Cal i fo rn i a, t o M i am i Beach , Fl o ri d a. In Sep t em b er 2 0 0 7 h e p u rch as edthe res id en ce i n M i am i Beach , Fl o ri da (M i am i h ou s e), fo r ap p ro x i m at el y $ 1 1 .2 m i l l i o n , m ak i n g a $ 5 m i l l i o n d o wnp aym en tan d o b t ai ni n g a m o rt g ag e fo r t he res t . He d i dn otd efau l to n th e
m o rt g ag e an dev en tu al l y

s o l dth e h o u s e i n l at e 2 0 0 9 fo r ap pro x i m at el y $ 9 .2
m i l l io n .- 4 4 -

[* 4 4 ] M r. Kel l y

m arri edNi co le Dah m

o n Oct o b er 4 , 2 00 8
. InAu g u s t 2 0 0 9 M r. Kel l y m o v edb ackt o San Di eg o, Cal i fo rn i a, i n i t i al ly m o v i n g b acki n to h i s co n d o i n San D i eg o , Cal i fo rn i a (San Di eg o co n d o). He s o l dth e San Di eg o co n d o o n No v em b er 8 , 2 0 1 1 , fo r $ 3 m i l l i o n . Inl at e 2 0 09 h e p u rch as ed h is cu rren th o m e i n Ran ch o San t a Fe, Cal i fo rn i a, fo r $ 8 .9 2 m i l li o n , o b t ai ni n g a $ 5 m i l l i o n m ort g ag e fro m Ban k o f Am eri ca an d u s i ng the p ro ceed s o f h i s M i am i h o u s e s al e t o p ay th e
rem ai n d er o f t h e p u rch as e p ri ce. As o f Decem b er 3 1 , 2 0 1 0 , M r. Kel l y

al s o o wn ed
a co n do i n W o o ds t ock , Geo rg i a. VII. Retu rn Rep o rt in g In 2 0 0 0 M r. Kel l y

ret ai nedF. Lau ren ce Sco t t , J r., o f Sco t t& Cro ni n , LLP (S&C), t o p rep are h i s p ers o n al retu rn fo r 1 9 9 9 . M r. Sco t twas M r. Kel l y ’ s p ri m ary
co n tactatS&C. M r. Sco t tan dJ as o n Bru st k ern , al s o o f S&C, were i n v o l v edi n th e p rep arat i o n o f M r. Kel l y ’ s 2 0 0 7 th ro u g h 2 0 1 1 p ers o n al return s . Bo t h m enare C.P.A.s wi t h n o h is t o ry

o f ad v ers e d i s ci pl i n ary

act i o n s o r In t ern al Rev enu e Serv i ce (IRS) p rep arer p en al t i es . M r. Kel l y recei v edan d rep o rt edwag es fro m NSI o f ap p ro x i m at el y

$ 1
m i l l io n p er y ear fo r 2 0 0 7 an d2 0 0 8 . He al so rep o rt ed a m i n i m al am o u n to f wag es fro m FCC o f l es s t h an $ 1 0 ,0 0 0 p er y ear fo r each o f t h e y ears ati s s ue.- 4 5 -

[* 4 5 ] As ex p l ai n edab o v e, M r. Kel ly d i dn ot cau s e h i s s i n gl e-m em ber LLCs t o fi l e
en t i ty -l ev el retu rn s . In s t ead , h e rep o rt edth e t ax i t em s fo r t h e LLCs o n Sch edu l es C at t ach edt o h i s p ers o n al retu rn s. See s ec. 3 0 1.7 7 0 1 -3 (b ), Pro ced . & Ad m i n . Reg s. (p ro v i d i n g t h ata s i ng l e-m em b er LLC i s a d is reg ard eden t i t y ). Acco rd in g ly , Kel l y Cap it al , Kel l y In v es t m en ts , Kel l y

Ho s p i t al it y , FSIF, Vi rtu co n , KY&C, Rad iu s M o rt g ag e, an dLBHo ri zo n s d i dn ot fi l e en t i t y -l ev el retu rn s fo r t h e y ears ati s s u e, an dKel ly

Fi n an ce d i dn o tfi le en ti t y -l ev el return s fo r 2 0 0 7 t h ro u g h 2 0 0 9 , th e y ears o f i t s ex is t en ce. M r. Sco t tp rep aredth e Sch edu l es C fo r KY&C t h atwere at tach edt o M r. Kel l y ’ s 2 0 08 an d 2 0 0 9 p ers o n al retu rn s . OnAp ri l 3 , 2 0 09 , M r. Th o m as s en tan
em ai l t o M r. Sco t t s t at i n g t h at [KY&C] i s a Caym anIs lan dEn t i t y an dI am n o ts u re wh att ax es an d retu rn s h av e t o b e fi ledi n th e Caym an Is l an d s . * * * I am n ots u re wh atfi l i n g req u irem en t s we h av e i n th e US s i n ce t h i s i s a Caym an Is l an den t i t y an dh o w th i s fl o ws th ro u g h t o M i ch ael Kel l y ’ s p ers o nal retu rn b uti twi l l h av e t o b e d eal t wi t h wh en fi l i n g retu rn s fo r 2 00 8
. Des pi t e t h i s m es s ag e, Fo rm 5 4 7 1 was n o tfi l edfo r KY&C fo r 2 0 0 8 . Att ach edt o M r. Th o m as ’ Ap ri l 3 , 2 0 0 9, em ai l were s ev eral “ LLC In fo rm at i o n Sh eet s ”, o n e o f wh i ch l i s t edKY&C as a Caym an Is l an d s en t i t y o wn ed1 0 0 % b y

Kel l y Cap i t al
.- 4 6 -

[* 4 6 ] VIII. Th e Au d i t M r Kel l y ’ s au d i tb eg an w i t h an ex am i n at i o n o f h i s 2 0 10 p ers o n al retu rn o n
o r aro u n d Sep tem

ber 1 7 , 2 0 1 2. OnOct o b er 1 , 2 01 2 , 1 4 d ay s aft er t h e i n i t ial
co n tactl et t er, M r. Sco ttan d/ or M r. Bru s t k ern co n t act edthe rev enu e ag en t
as s i g n edt o th e au di t . Aft er an ex ch an g e o f v o i cem ai l s t o s ch edu le a p h o n e
co n feren ce fo r Oct o b er 1 2 , 2 0 1 2 , th e rev en u e ag en t m i s sedth atp h o n e co n feren ce b u to n Oct ob er 2 4 , 2 01 2 , requ es t eda m eet i n g wi th M r. Kel l y i n a t el ep h o n e cal l wi th M r. Sco tt . Onth ats am e d ay , M r. Sco tts en ta l et t er t o t h e rev en u e ag en t
en cl o s i n g t ax retu rn s th atth e ag en th ad req u es t ed
. OnNo vem

b er 2 0, 2 0 1 2 , M r. Kel l y

an d h i s rep res en t at i v es m etwi t h t h e
rev en u e ag en tatM r. Kel l y ’ s o ffi ce. M r. Kel l y p art ici p at edi n th e m eet i n g an d
an s weredth e qu es t io n s th atth e rev en u e ag en tas k ed . Th e m eet i n g was cu ts h o rt b y th e rev en u e ag en t , n o tM r. Kel l y o r h i s rep res en t at i v es . Gen eral l y , requ es t ed
reco rd s were freel y p ro v i d ed b y M r. Kel l y

o r M r. Sco ttt o t he IRS. M r. Kel l y was
n o ts u m m o n edt o m eetwi t h th e IRS. Th ere were b et ween 1 5 an d2 0 v ol u n t ary m eet i n g s b et ween IRS rev en u e ag en ts an dM r. Kel l y

o r h i s rep res en t at i v es duri n g t h e co urs e o f t he ex am i n at i o n . Th ere were al s o atl eas t t h ree v o l u n t ary m eet in g s b et ween th e IRS Offi ce o f Ap p eal s an d M r. Kel ly ’ s rep res en t at i v es fo l l o wi n g th e au di t . M r. Kel l y an s wered- 4 7 -

[* 4 7 ] al l th e IRS’ qu es t io ns atth e s ub s equ en t m eet i n g s wh ere h e was p res en t . In
s h o rt , h e co o p erat edwi t h th e au d i t . He ag reed t o ex t en d t h e p eri o d s o f l i m i t at i o n s wh en th e IRS as kedh i m

t o d o s o . Res p o n d en ti s su edtwo n o t i ces o f d efi ci en cy t o M r. Kel l y , th e fi rs to n Decem b er 1 0 , 2 0 15 , fo r t ax y ears 2 0 1 0 an d 2 0 1 1 , an dth e s eco ndo n M ay 1 9 , 2 0 1 6 , fo r t ax y ears 2 0 0 7 , 2 0 0 8 , an d2 00 9 . Th e s eco n d n o t i ce o f d efi ci en cy was th e fi rs tfo rm al co m

m u n i cat i o n t o M r. Kel ly

o f t h e i n it i al d et erm i n at i o n t o as s es s p en al t i es fo r t ax y ears 2 00 7 , 2 0 0 8 , an d2 0 0 9 . Res p o n d en t ’ s i n i t i al d et erm i n at i o n
o f t h e frau dp en al t y

u n d er s ect i o n 6 6 6 3 (a) fo r 2 0 0 7 , 2 0 0 8 , an d 2 0 09 was p ers o n al l y

ap p ro v edi n wri t i n g b y

th e i m m ed i at e s up erv i s o r o f th e IRS em p l o y ee wh o m ad e t h e i n i t i al d et erm i n at i o n , as req u i redb y s ect i o n 6 7 5 1 (b ), o n Oct o b er 8 , 2 0 1 5 , a d at e b efo re th e m ai li n g o f t h e n o t i ce o f d efi ci en cy fo r t h o se y ears . OPINION I. St atu t e o f Li m it at i o n s Th e p eri o d o f l i m i t at i o n s u n der s ect io n 6 5 0 1 i s i n d i s p u t e fo r 2 00 7 , 2 0 0 8 , an d 2 0 0 9 . Res p o n d en targ ues t h e fi l i ng o f fal s e o r frau dul en treturn s wi t h th e i n t en tt o ev ad e t ax u n d er s ect i o n 6 5 0 1 (c)(1 ). He arg u es t h atth e p eri o d s o f l i m i tat i on s rem ai n o p en u n d er s ect i o n 6 5 0 1(c)(8 ) fo r 2 0 0 8 an d2 0 0 9 o n th e b as i s th atM r. Kel l y

fai ledt o fi l e t im el y

Fo rm s 5 4 7 1 t o rep o rtKY&C as a co n t ro l l ed- 4 8 -

[* 4 8 ] fo rei g n co rp o rat i o n as req u i redb y s ect i o n 6 0 3 8 (a)(1 ) fo r t h es e t wo y ears . Res po n d en tal s o arg u es th atth e s i x -y ear ru l e fo r a s ub s t an t i al o m i s s i o n fro m g ro s s i n co m e u n d er s ect i o n 6 5 0 1 (c)(1 ) an d(e) p ro v id es a s ep arat e g ro u n d t o as s es s a d efi ci en cy

fo r 2 0 0 9 . W e l at er h o l dth atfrau d i s n o ts u s t ai n ed , s o we m us trev i ew
res p o n d en t’ s al tern at iv e p os i ti on s . M r. Kel l y ack n o wl ed ges th at2 0 0 9 i s p o t en t i al ly s ub

ject to th e s i x -y ear ru l e o f s ect io n 6 50 1 (e) fo r a s ubs t an ti al o m i s s i o n fro m g ro s s i n co m e. M r. Kel l y fi l edth e Fo rm s 5 4 7 1 fo r 2 0 0 8 an d 2 0 0 9 i n 2 0 1 9. Acco rd i n g l y , s ect i on 6 5 0 1 (c)(8 ) m ay

h o ld o p en th e 2 0 0 8 an d2 0 0 9 p eri o ds o f l i m it at io n s u n t i l Oct o b er 2 3 , 2 0 2 2 , th ree y ears fro m wh en M r. Kel l y

fi l edth e Fo rm s 5 4 71
. Ho wev er, i f reas o n ab l e cau se fo r t h e fai l u re t o fi l e Fo rm s 5 4 7 1 ex i st s , th en u n d er
s ect i on 6 5 0 1 (c)(8 )(B) o n l y t h e ad ju s t m en ts rel at edt o KY&C wo ul d rem ai n o p en
u n d er t h e s t atu t e o f l i m i t at io ns . Pet i t i o n er as s ert s t h atreas o n ab le cau se ex is t s an d
s t em s fro m

th e fai l u re o f M r. Kel l y ’ s t ax retu rn p rep arer, S&C, t o fo l l ow t h ro u g h
o n th e i n fo rm at i o n M r. Kel l y an dh i s s t aff p ro vi d edt o i t
. Sect io n 6 5 0 1 (c)(8 ) d o es n o td efi n e reas o n ab l e cau s e. No r d o th e reg u l at i on s th ereu n d er. Ho wev er, i ti s ap p ro p ri at e t o rel y o n th e Sup rem e Co urt ’ s d efi n i t i o n i n Un it edSt at es v . Bo y l e, 4 6 9 U.S. 2 4 1 , 2 4 6 (1 9 8 5 ), th atth e t ax p ay er m u s t
ex erci s e “ [o ] rd i n ary

b u s i n es s care an dp ru d en ce” (q uo t in g s ect i o n 3 0 1.6 6 5 1
-- 4 9 -

[* 4 9 ] 1 (c)(1 ), Pro ced . & Ad m i n . Reg s .). W e h av e rel i edo n th i s d efi n i t i o n fo r t h e
reas on ab l e cau s e d efen s e t o th e s ect i o n 6 0 3 8 (b ) p en al t y fo r a fai l u re t o fu rn i s h th e ap p ro p ri at e i n fo rm at i o n wi t h a retu rn . See Fl u m e v . Co m m i s s io n er, T.C. M em o . 2 0 1 7 -2 1 . Tax p ay ers can es t ab l i s h reas o n ab l e cau s e o n th e b as i s o f t h ei r rel i an ce
o n th e ad v ice o f a t ax p ro fes s i o n al . Id . Su ch rel i an ce req u i res th atth e t ax p ay er p ro v e: (i ) t h e ad v i s er was a co m p et en tp ro fes s i o n al wi t h s uffi ci en t ex pert i s e, (i i ) th e t ax p ay er p ro v id edn eces s ary an daccu rat e i n fo rm at i o n t o the ad v is er, an d(i i i ) th e t ax p ay er rel i edi n g o o d fai t h o n t h e ad v i s er’ s ju d g m en t . Neo nat o l o g y As s o cs ., P.A. v . Co m

m i s s i on er, 1 1 5 T.C. 4 3 , 9 8 -9 9 (2 0 0 0 ), aff’ d, 2 9 9 F.3 d2 2 1 (3 dCi r. 2 0 0 2 ). Th e t ax p ay er’ s edu cat i o n an db u s i n es s ex p eri en ce are rel ev an tt o d et erm i n e wh eth er h e reas o n ab l y an di n g o o d fai t h rel i edo n a t ax p ro fes s i o n al
. Sec. 1 .6 6 6 4 -4 (b )(1 ), In co m e Tax Reg s . S&C h as p rep aredM r. Kel l y ’ s p ers o nal retu rn s s i n ce 2 0 0 0 , i n cl ud i n g Sch edu l es C fo r h i s affi li at edco m p an i es . S&C p rep aredap p ro x i m at el y 7 00 t ax retu rn s p er y ear. M r. Sco t twas th e p ri m ary co n t actfo r th e p rep arat i o n o f M r. Kel l y ’ s return s . M r. Sco t t i s a C.P.A. wi t h n o h i s to ry o f adv ers e d is ci pl i n ary act i on s o r IRS p rep arer p en al t ies . He h add ecad es o f ex peri en ce wi t h Fed eral t ax retu rn p rep arat i o n b u th adn o p ri o r kno wl ed ge o f Fo rm 5 4 71 i n 2 0 0 9 . Itwas
reas on ab l e fo r M r. Kel l y

t o rel y o n M r. Sco t t . S&C was ad equ at el y ad v i s edth at- 5 0 -

[* 5 0 ] M r. Kel l y o wn eda Caym an Is l an d s en t i t y . M r. Kel l y ’ s s t aff p o i n t edo u tthat th ere m i g h tb e a d i fferen trep o rt i n g . Co nv ers el y , i n Fl u m e, t he t ax p ay er fai l edt o p ro v id e h i s t ax retu rn p rep arer al l th e n eces s ary i n fo rm at i o n . Res p o n d en tco n t en d s th ati twas n oten o u g h fo r M r. Kel l y t o i n fo rm

S&C th atKY&C was a fo rei g n en ti t y , an dh e i m p li es t h atM r. Kel l y

s h o u ldh av e ad v is edM r. Sco t tthatFo rm 5 47 1 was req u i red . Th e fai l u re t o fi le t h e Fo rm s 5 4 7 1 d o es no tp res en t an o b v i o us t ax o b l i g at i o n wh i ch was n eg l i gen t l y o m i t t edfro m i n fo rm at i o n th ata t ax p ay er p ro v i d edt o the ret u rn p rep arer. M r. Kel l y , th ro u g h h i s
s t aff, p ro v i d edth e n eces s ary i n fo rm at i o n t o S&C, i d en t i fi edKY&C as a fo rei g n
co rp o rat i o n, an ds t at edth ath e was u n s u re o f t h e rep o rt i n g req u i rem en t s . Hav i n g d o n e t hi s , M r. Kel l y

reas on ab l y

rel i edo n S&C t o p rep are h is retu rn s p ro p erl y . Wh i l e i tco u l db e arg u edth atS&C s h o u l dh av e d on e m o re t o as cert ai n M r. Kel l y ’ s fi li n g o b l i g at i o n s , i t was reas o n ab le fo r M r. Kel ly t o rel y o n S&C d o s o . A t ax p ay er n eedn o tqu es t i o n th e ad v i ce p ro v id ed , o b t ai n a s eco n do p i n i o n , o r
m o ni t o r th e ad v i ce recei v edfro m th e p ro fes s i o n al . Bo y l e, 4 6 9 U.S. at2 5 1. Attri al , M r. Sco t tcred i b l y d es cri b ed t he reas o ns th at h is fi rm fai l edt o p rep are Fo rm

5 4 7 1 fo r KY&C. No fact s s u g g es tth atth e fai l u re was th e res u l to f a
co n fl i cto f i n teres to r a “ t o o g o o dt o b e t ru e” s i tu at i o n fo r ei t h er y ear. Ul t im at el y , M r. Kel l y ’ s rel i an ce o n S&C t o h el p m eeth i s fi l i n g o b l i g at i on s was reas o n ab l e- 5 1 -

[* 5 1 ] an d d o ne i n g o o d fai t h , an dth e p eri od s o f l i m i t at i o n s fo r 2 0 0 8 an d2 0 0 9 d o
n o trem ai n o p en fo r ad

ju s t m en t s u n rel at edt o KY&C u n d er s ect i o n 6 5 01 (c)(8 )(A) aft er t h e ap p l i cat io n o f s ect i o n 6 5 0 1 (c)(8 )(B). In fact , res p on d en td i d n o tad v i s e M r. Sco t tab o u t t h e n o n fi l i n g o f t h e Fo rm s 5 4 71 u n t i l 2 0 19 , th ree y ears aft er th es e
cas es b eg an . M r. Sco t tp rep aredan dfi l edth e Fo rm s 5 4 7 1 qu i ck l y t hereaft er. W e h o l dth atM r. Sco t t ’ s l acko f p ri o r ex p eri en ce wi th Fo rm 5 4 7 1 was n otfat al t o a fi nd i ng o f M r. Kel l y ’ s reas on ab l e rel i an ce o n h i m o r S&C. II. Frau d Res p o n d en td et erm i n edfrau dp en al t i es u n d er s ect i o n 6 6 6 3 , fo r wh i ch
res p o n d en t b ears th e b u rd en o f p ro o f b y cl ear an dco n v in ci n g ev i d en ce. See s ec. 7 4 5 4 (a); Ru le 1 4 2 (b ). Res p on den t ’ s b u rd en i s t o p ro ve, fo r each y ear, b y cl ear an d
co n vi n ci n g ev id en ce, t h at(1 ) M r. Kel l y u n d erp ai dh i s t ax fo r th aty ear an d (2 )
s o m e p arto f t h atu n d erp aym en tfo r t h aty ear was du e t o frau d . See Park s v . Co m m i s s i o n er, 9 4 T.C. 6 54 , 6 6 0 -6 6 1 (1 9 9 0 ). Frau dfo r t hes e p u rp o ses i s d efi n edas i n t en ti o n al wro n gd o i n g wi t h th e
s p eci fi c p u rp o s e o f av o i d i n g a t ax b el i ev edt o b e o w ed . Di L eo v . Co m m i s si o n er, 9 6 T.C. 8 5 8 , 8 7 4 (1 9 9 1 ), aff’ d , 9 5 9 F.2 d1 6 (2 dCi r. 1 99 2 ). St at edd ifferen t l y , i m p o s i t i o n o f t h e ci v il frau dp en al t y i s ap p ro p ri at e up o n a s h o wi n g b y th e Co m m i s s i o n er t hatth e t ax p ay er i n t en d ed t o ev ad e t ax es b el i ev edt o b e o wi n g b y- 5 2 -

[* 5 2 ] co ndu ct d es i g n edt o co n ceal , m i s l ead , o r o th erwi se p rev en tth e co l l ect i o n o f t ax es . Id .; s ee al s o Pet zo ld t v
. Co m m i s s i o ner, 9 2 T.C. 6 61 , 6 9 8 (1 9 8 9 ). Bu tfrau d

“ d o es n o t i n cl ud e n eg l i g en ce, carel es s n es s , m i s u nd ers t an di n g o r u n i n ten t i o n al
u n d ers t at em en to f i n co m e.” Un i t edSt at es v . Pech en i k, 2 3 6 F.2 d 8 4 4 , 8 4 6 (3 dCi r. 1 9 5 6 ). Frau d “ is n otp ro v en wh en a co u rti s l eftwi th o n l y a s u s p i ci o n o f frau d , an d ev en a s tro n g s us p ici o n i s n o ts u ffi ci en t t o es t ab l i s h a t ax pay er’ s l i ab i l i t y fo r th e frau dp en al t y .” Bran s on v . Co m m i s s i o n er, T.C. M em o . 2 0 1 2 -1 2 4, s l i p o p . at 2 3 (ci t in g Ol in g er v . Co m m i s s i o n er, 2 3 4 F.2 d 8 2 3 , 8 2 4 (5 t h Ci r. 1 9 5 6 ), aff’ g i n p art , rev ’ g i n p art o n an o t h er g ro u n dT.C. M em o . 1 9 5 5 -9 , Dav is v . Co m m i s s i o n er, 1 8 4 F.2 d8 6 , 8 7 (1 0 t h Ci r. 1 95 0), an dGreen v . Co m m i s s i o n er, 6 6 T.C. 5 3 8 , 5 5 0 (1 9 7 6)). M o reo ver, ev en wh en a t ax p ay er “ en g ag e[s ] i n ag g res s i v e t ax p l an n i n g t o
m i n i m i ze h i s t ax es ”, t h i s Co u rth as fo u n dth ats u ch act i o n al on e i s n o ten o u g h t o
es t ab l i s h t h e req ui s it e frau du l en ti n ten t . Kl aas v . Co m m i s s i on er, T.C. M em o . 2 0 0 9 -9 0 , s l i p o p . at3 3 , aff’ d , 6 2 4 F.3 d1 2 7 1 (1 0 t h Ci r. 2 0 1 0). As d i rect p ro o f o f a t ax p ay er’ s i n t en ti s s el d o m av ai l ab l e, frau d h as b een
es t ab l i s h edb y ci rcu m s t an t i al ev i d en ce an dreas o n ab l e i nferen ces drawn fro m th e
reco rd . St o l tzfu s v . Un i tedSt at es , 3 9 8 F.2 d1 0 02 , 1 0 0 5 (3 dCi r. 1 9 6 8); Di Leo v . Co m m i s s i o n er, 9 6 T.C. at 8 7 4
. Co u rt s h av e t h u s d ev el o p ed a l i s to f “ b ad g es o f frau d” u s efu l i n d et erm i n i n g wh et h er t h ere i s ci rcu m s t an t i al ev i d en ce o f frau du l en t- 5 3 -

[* 5 3 ] i n t en t . Ni ed ri ng hau s v . Co m m i ss i o ner, 9 9 T.C. 2 0 2 (1 9 9 2 ). Am o n g th e b ad ges o f frau dth atcan b e g at h eredfro m th e cas el aw o f t h e Co u rt o f Ap p eal s fo r th e Ni n th Ci rcu i t , t o wh ich th es e cas es are ap p eal ab le, are t h e fo ll o wi n g : (1 ) an
u n d ers t at em en to f i n co m e, (2 ) i n ad equ at e m ai n t en an ce o f reco rd s , (3 ) a fai l u re t o fi le t ax retu rn s o r t h e fi l i n g o f fal s e ret urn s , (4 ) o fferi n g i m p lau s i b l e o r i n co n s i s t en tex p l an at i o n s o f b eh av i o r, (5 ) co nceal m en to f i n co m e o r as s et s , an d (6 ) fai l u re t o co op erat e wi t h t ax au t h o ri t i es . Brad fo rdv . Co m m i s s i o n er, 7 9 6 F.2 d 3 0 3 , 3 0 7 -3 0 8 (9 t h Ci r. 1 9 8 6 ), aff’ g T.C. M em o . 1 98 4 -6 0 1. Co u rt s h av e al so
co n si d ered : (7 ) en g ag i n g i n i l l eg al act i vi t i es ; (8 ) d eal i ng i n cas h ; (9 ) fai l in g t o
m ak e es ti m at edp aym en t s ; (1 0 ) o fferi ng fal s e o r i n cred i b l e t es t i m o n y ; an d (1 1 ) fi li n g fal s e d o cu m en t s . Ni ed ri n g h au s v . Co m m i s s i o ner, 9 9 T.C. at2 1 1 ; Park s
v . Co m m i s s i o n er, 9 4 T.C. at6 6 4 -6 6 5
. Ad d it i on al l y , th e t ax pay er’ s b ack gro u n d , l ev el o f edu cat i o n, an dp ri o r h i s t o ry o f fi l i n g p ro p er retu rn s are rel ev an t . Ni edri n g h au s v . Co m m i s s i o n er, 9 9 T.C. at2 1 1 . A t ax p ay er’ s edu cat i o n an ds o p h i s t i cat i on are n o tth em s el ves b ad ges
o f frau db u tare rel ev an t fact o rs i n d et erm i n i n g “ whet h er a t ax p ay er co u l dh av e fo rm edth e i n t en tn eces s ary t o b e fo u n dl i ab l e fo r t h e frau d p en al t y . ” Ho l m es v . Co m m i s s i o n er, T.C. M em o . 2 0 1 2 -2 5 1 , at* 3 1 n .1 6 (qu o t i n g W ick ers h am v .- 5 4 -

[* 5 4 ] Co m

m i s si o n er, T.C. M em o . 1 99 9 -2 67 , s l i p o p . at 1 2 ), aff’ d, 5 9 3 F. Ap p ’ x 6 9 3 (9 th Ci r. 2 0 15 ). Res p o n d en tas sert s th e fo l l o wi n g b ad g es o f frau d : (1 ) co ns i st en tu n d ers t at em en t s o f t ax fo r 2 0 0 7, 2 0 0 8 , 2 0 09 , 2 01 0 , an d 2 0 1 1 ; (2 ) co nceal m en t o f i n co m e b y M r. Kel ly

t el l i ng h i s s t aff t h atth e NSI tran s fers were l o an s ev en tho u g h h e p l an n edt o l i qu i d at e NSI an dn ev er i n t en d ed t o p ay b ackth e t ran s fers ; (3 ) i m p l au s i b l e an di n co n s i s t en t s tat em en t s m ad e b y M r. Kel ly , s u ch
as h i s t es t i m o n y

th ath e wan t edt o u s e t h e fu n d s fro m NSI t o i n ves ti n o th er b u s i n es s o p p o rtu n i t i es , b u th ads p en tm i l l io n s o f d o l l ars o f p u rp o rt ed l y b o rro wed
m o ney o n p ers o n al ex p en ses an dd i dn o t g i v e NSI an y o wn ers h i p i n t eres ti n th e b u s i n es s v en tu res i n wh ich i t was s up p o s ed l y i nv es t i n g ; (4 ) p ro v i di ng fal s e an dm i s l ead in g i n fo rm at i o n t o S&C ab o u tth e tran s fers fro m

NSI i n cl u d in g fal s e b o o k s an d reco rd s th atM r. Kel l y m ai n t ai n ed fo r h i s b u s i n es s es thatreco rd edth e t ran s fers fro m NSI as l oan s ; (5 ) i n ad equ at e reco rd s an dfal s e d o cu m en t s t o refl ectth e t erm s o f t he p u rp ort edl o an s fro m

NSI an d t h e fi li n g o f Fed eral t ax retu rn s fo r 2 00 7 th ro u g h 2 0 0 9 thato m i tt eds ub s t an t i al am o un t s o f i n co m e; an d- 5 5 -

[* 5 5 ] (6 ) a s ch em e t hatM r. Kel l y d es i g n edt o d efrau dcred it o rs i n cl u di n g th e IRS, t o u s e NSI’ s as set s as a p ig g y b an kfo r h i s p ers o n al s p en d i ng an d t o
can cel th e d eb t , an dt o as s ert t h e i n s o l v en cy o f NSI t o av o i d p ay i n g t ax . Res p o n d en t ’ s l i s t d ep en d s t o t al ly o n th e p rem i s e t h atM r. Kel l y ’ s i n t erco m p an y tran s fers o r wi t h drawal s reco rd edas l o an s were n o tp ro p erl y treat ed
as l o an s an dwere co nceal edwi t h i n t en tt o d efrau dth e Un i tedSt at es . Wh i l e we d o
n o tp res u m e t h e acco u n t i ng b y M r. Kel ly an dh i s co m

p an i es i s al way s accu rat e reg ard i n g th e “ l o an s ”, we d o n otb el i ev e t he reco rdes t ab l i s h es b y cl ear an d
co n vi n ci n g ev id en ce t h at t h e “ l o an s ” were t h e b as i s o f a frau du len tt ax s ch em e; rat h er t h ey

were t h e p ro du ct s o f t wo d ecad es o f M r. Kel ly ’ s b us i n es s p ract i ces . As we d i scu ss l at er h erei n , we ag ree wi t h res p o n d en tth atb y 2 00 8 there was n o
reas on ab l e ex p ect at i on th e “ lo an s ” wo u l db e rep ai d wh en i n cu rred , an dth ey
s h o u ldb e t reat edas d i s t ri bu t i o n s . Th is co n cl u s i o n d o es n o ti n i t s el f l eadt o a fi nd i ng o f frau d
. Res p o n d en tal l eg es b u tfai l s t o p ro v e an i n ten t t o d efrau d cred i t o rs , co n ceal m en t o f i n co m e o r as set s , frau dul en tfai lu re t o fi l e ret u rn s , an d fal s e
s t at em en t s . Rat h er, M r. Kel l y ’ s co m p an i es ’ acco u nt i n g reco rd s rev eal edth atth e tran s fers were reco rd edas l oan s as an es t ab l i s h edp ract i ce o f h i s b u s i n es ses . M r. Kel l y h ada h i s t ory o f ju g g li n g al l th e s o u rces o f cas h i n h i s v ari o u s en t erp ri s es t o- 5 6 -

[* 5 6 ] l ev erag e o p p o rtu n i t ies
. He treat edth e cas h as av ai l ab l e t o h i m an d b efo re th e y ears ati s s u e h e u s edth i s s t rat eg y t o b u i l dthe p o rt fo l i o o f as s et s h e co n t ro l l ed
. He d i d n o t h id e thes e t ran s act i o n s , an dthe t ran sact i o n s were t rack edi n th e reco rd s
o f h i s co m

p an ies
. M r. Kel l y res p ect edh i s acco u n t i n g s t aff. He res p ect ed t h e s ep arat e
co rp o rat e en ti t ies an dth ei r acco u n t i n g reco rd s , wh i ch reco rd ed t h e t ran s fers o f fu n d s g en eral l y as l o an s . Res p o n d en t al l eg es th atth es e l o an s were frau du l en tan d th atM r. Kel l y

h as co m m i tt edt ax frau d o n t h e b as i s o f t h e t ran sfers ’ ch aract eri zat i on s as l o an s . Res p on d en t ’ s p o s i t i o n i s i n effect th atM r. Kel l y h adb een en g ag ed i n t ax frau ds i n ce t h e 1 9 90 s wi t h h i s p ract ice o f u s in g i n t erco m p an y l o an s o r t h at M r. Kel l y ’ s p ract i ce b ecam e frau du l en t wi th the NSI acq u i s i t i o n . W e fi ndth at
res p o n d en t h as fai l edt o es t ab l i s h frau du l en ti n t en t b y cl ear an dco n v i n ci n g
ev i d en ce o n t h e b as i s o f ei t h er p rem i s e. Reg ard les s o f wh et h er t h e l o an s were p ro p erl y ch aract eri zedas s u ch fo r t ax acco u n t i ng p u rp o ses , th e ev i d en ce d o es n o t p ro v e th atth e l o an ch aract eri zat i o n s were m ad e wi th frau du l en ti n ten t
. III. In t erco m

p an y Tran s fers A k ey i s s u e, i f n o tth e k ey

i s s u e i n t h es e cas es , i s wh et h er a s eri es o f tran s fers fro m

NSI t o M r. Kel l y

an dh i s en ti t ies were b o n a fi de l o an s o r s h o u l db e recl as s ifi edas t ax ab l e d i s t ri b u t i o n s. M r. Kel l y h as co n s is t en t l y

m ai nt ai n edth at- 5 7 -

[* 5 7 ] th ey

were l o an s , b u tres p o n d en td i s ag rees . As res p o n d en tco rrect l y b eg i n s , an i n t en tt o es tab l i s h a d eb to r-cred i t o r rel at i o n sh i p ex is ts i f, wh en th e t ran s fers
were m ad e, t h e d eb t o r i nt en d edt o rep ay th e fu n d s an dth e cred i t o r i n t en dedt o
en fo rce rep aym en t. See, e.g
. , Beav er v . Co m m i s s i o n er, 5 5 T.C. 8 5 , 9 1 (1 9 7 0 ); Fi s h er v . Co m

m i s s i o n er, 5 4 T.C. 9 0 5, 9 0 9 -9 1 0 (1 9 7 0 ). Th i s i s al s o a qu es t i o n o f fact t o be d et erm in edup on a co n s i d erat i o n o f al l p ert i n en t fact s. Hab er v . Co m m i s s i o n er, 5 2 T.C. 2 55 , 2 6 6 (1 9 6 9 ), aff’ d , 4 22 F.2 d 1 9 8 (5 t h Ci r. 1 9 7 0 ). A b o n a fi d e d eb t i s a d eb tth at ari s es fro m a d eb t o r-cred it o r rel at io ns h ip o n th e b as i s o f a v al i dan d en fo rceab l e o b li g at i on t o p ay a fi xedo r d et erm i n ab l e s u m o f m o n ey . * * * Wh et h er an ad van ce g i v es ri se t o a b o na fi d e d eb tfo r Fed eral t ax p u rp o s es i s d et erm i n edfro m al l th e fact s an dci rcu m s tan ces . * * * To co ns t i tu t e a b o na fi d e d eb t , atth e t i m e o f the t ran s fer t h ere m u s tb e a real ex p ect at i o n o f rep aym en tan dan i n ten to n th e p arto f t h e p u rp o rt edcred i t o r t o s ecu re rep aym en t . * * * 2 5 9 0 As so cs ., LLC v . Co m m i s s i o n er, T.C. M em o . 2 0 1 9-3 , at * 21
. Cas el aw h as es t ab l i s h edo b ject i v e fact o rs t o co n s i d er wh en an sweri n g th e qu es ti o n o f wh et h er a b o n a fi d e d eb t o r-cred i t o r rel at i on s hi p ex i s t s . Th o se fact o rs i n cl u d e: (1 ) wh et h er t he p ro m i s e t o rep ay i s ev id en cedb y a n o t e o r o t h er i n s tru m en t t h atev i d en ces i n d eb t ed n es s, (2 ) wh et h er i n t eres twas ch arg edo r p ai d , (3 ) wh et h er a fi x ed s ch edu le fo r rep aym en tan da fi xedm atu ri t y d at e were
es t ab l i s h ed , (4 ) wh et her co l l at eral was g i v en t o s ecu re p aym en t , (5 ) wh et h er- 5 8 -

[* 5 8 ] rep aym en t s were m ad e, (6 ) wh atth e s o u rce o f an y p aym en t s was , (7 ) wh et h er t h e b o rro wer h ada reas o n ab l e p ro s p ect o f rep ay i n g th e l oan an d wh et h er t h e l en d er h ads u ffi ci en tfu n d s t o ad v an ce t h e l o an , an d (8 ) wh et h er t h e p art i es co n du ct edthem s el v es as i f t he t ran s act i o n was a l oan . Di x i e Dai ri es Co rp . v . Co m m i s s i o n er, 7 4 T.C. 4 7 6 (1 9 8 0 ); s ee al s o W el ch v . Co m m i s s i o ner, 2 0 4 F.3 d 1 2 2 8 , 1 2 3 0 (9 th Ci r. 2 0 0 0 ), aff’ g T.C. M em o . 1 9 9 8 -1 2 1; Es tat e o f M i x o n v . Un i ted St at es , 4 6 4 F.2 d3 94 , 4 0 2 (5 t h Ci r. 1 9 7 2); Co m m is s io n er v . Val l ey M o rri s Pl an , 3 05 F.2 d6 1 0 , 6 1 8 (9 t h Ci r. 1 9 6 2 ) (d efi n in g a l o an fo r Fed eral t ax p u rp o s es
as “ an ag reem en t , ei t h er ex p res s edo r i m p l ied , wh ereb y

o n e p ers o n ad v an ces
m o ney t o th e o t h er an dth e o t h er ag rees t o rep ay i tup on s u ch t erm s as t o t i m e an d rat e o f i n t eres t , o r wi t h o u ti n t eres t , as t h e p art i es m ay ag ree” (q u o t i n g Nat ’ l Ban k
o f Pau l d in g v . Fi d. & Cas
. Co ., 1 3 1 F. Supp . 1 2 1 , 1 2 3 (S.D. Oh i o 1 9 5 4 ))), rev ’ g i n p art3 3 T.C. 5 7 2 (1 9 5 9 ); Knu t s en -Ro wel l, In c. v . Co m m i ss i o n er, T.C. M em o . 2 0 1 1 -6 5
. Cri t i cal t o o u r an al y s i s , as i s o ft en th e cas e, i s fact o r (7 ). By 2 0 0 8 M r. Kel l y
n o l o n ger h ada reas o n ab l e p ro s p ecto f rep ay i n g th e “ l o an s ”. M r. Kel ly arg u es
o th er fact o rs s up p o rtch aract eri zat i o n as l o an s . He arg u es thatth e l o an s were
s up p ort edb y

th e accru al o f i n t eres tan d i n m os tcas es h i s co m pan i es fo l l o w ed fo rm al i t i es o f d o cu m en t in g the t ran s fers as l o an s . He al s o m ai n t ai n s thatth e- 5 9 -

[* 5 9 ] rep aym en twas d erai l edo n l y b y the d o wn tu rn i n the eco n o m y t h atad v ers el y affect edh i s real es tat e h o ld i n g s an dth e p ro fi tp o ten t i al o f h i s n u m ero us tran s act io n s . W e fi n d t h i s arg um en treas o n ab l e th ro u g h 2 0 0 7 , b u ti tl o s es cred i b i l i ty

aft er 2 0 0 7 wh en M r. Kel l y was wel l aware t h e eco no m y was tu rn i n g
n eg at i v e t o h is b u s i n es s es b u tco n t i n uedt o h av e fu n d s t ran sferred fro m NSI wi t h l es s an dl es s ex p ect at i o n o f rep aym en t
. Th e res p ectfo r l o an fo rm al i t i es al s o wan es as th e eco n o m y m ad e rep aym en t al l b u t i m p o s s ib le b eg i n n i n g i n 2 0 0 8 . M r. Kel ly ’ s co m p an ies fo l l oweda p ract i ce
o f carefu l acco u n t i n g o f l o an s wi t h s o m e rep aym en ts th ro u g h 2 00 7 , b u tres p ectfo r th e l o an ch aract eri zat i o n an drep aym en ts g radu al l y d i s ap p ear aft er 2 0 0 7
. Acco rd in g ly , we h o l dth atal l NSI t ran s fers an d o t h er i nt erco m p an y tran sfers are
n o tp ro p erl y ch aract eri zedas l oan s b eg i n ni n g o n J an u ary 1 , 2 0 0 8 . Th i s h o l d i n g affect s res p o n d en t’ s p o si t i o n o n wh et h er tran s fers are cap it al d i s t ri bu t i o n s o r d i v i d en d s an d , al t ern at i vel y , wh et h er M r. Kel l y h as COD i n co m e fo r 2 01 0
. W e h o l dth atth e t ran s fers b eg i n n i n g o n J an u ary 1 , 2 0 0 8 , were s h areh ol d er d i s tri b u t i o n s u n d er s ect i on s 3 0 1 an d 1 3 6 8 . Th i s h o l di n g wi l l req u i re
reco m pu t at i o n s u n d er Ru l e 1 5 5.- 6 0 -

[* 6 0 ] IV. COD In co m e an d BadDeb tDedu ct i o n fo r 2 0 1 0 Onh i s 2 0 1 0 p ers o n al retu rn M r. Kel l y rep o rt ed$ 1 4 5 m i l l io n o f COD i n co m e th ath e ex cl ud edfro m h i s g ro s s i n co m e o n t h e b as i s o f h i s al l eg ed i n s o l v en cy an dcl ai m ed a s h o rt -t erm cap i t al l o s s d edu ct i o n fo r b add eb to f $ 8 6 ,9 7 9 ,9 5 6 u n d er s ect i o n 1 6 6 (a)(1 ), wh i ch p ro v i d es fo r a d edu ct i o n o f an y b o n a fi de d eb twh i ch b eco m es wo rt h l es s wi t h i n a t ax ab l e y ear. M r. Kel l y m ad e
n u m ero u s tran s fers b et ween h i s cl o s el y h el d co m p an i es , an do n s o m e o ccas i o n s
reco rd edl o an s were fo rg i ven as s h areh o l der d i s t ri b u t i o ns . Th e COD i nco m e was b as edl arg el y o n i n t erco m

p an y l o an s an d was n o t cal cu l at edwi t h preci s i on t o el i m i n at e i n t erco m p an y d eb to r t o en s u re t h at o n l y h i s p ers o n al d eb twas actu al l y fo rg i v en . Li k ewi s e, t h e cap i t al l o s s d edu ct io n fo r t h e b ad d eb twas cal cu l at ed u s i n g th e t o t al o f th e reco rd ed i n t erco m p an y d eb t s . Pet i t io n er’ s b ri ef d i s cu s s es th e i s s u es as fo l l o ws : In es s en ce, b ecau s e t he d eb twas can cel l ed , wh i ch was p i ck edup an d rep o rt edb y

M r. Kel l y

as can cel l at i o n o f d eb ti n co m e, t h e o t h er s i d e o f t h e s am e co i n was a b add eb td educt i o n . As M r. Bru s t k ern t es t i fi ed , i twas a “ zero s u m ”: wi t h ou to ne y oucan n o th av e t h e o t h er. Fo r ex am pl e, wh en [Kel l y

Cap i t al ] was n o tab l e t o co l l ectth e d eb t s o wedt o i tfro m

v ari o u s en t i t i es , th e am ou n twas can cel led , creat i n g M r. Kel l y ’ s Sch edu l e D b add eb td edu ct io n . Co ncu rren t l y , wh en th e d eb t o wedt o [Kel l y

Cap i t al ] was can cel led , M r. Kel ly p ick edup th e am o u ntas can cel lat i o n o f d eb ti n co m e. Th e zero s u m n atu re o f t hi s rep o rt i n g i s al s o ev i d en cedb y th e fact M r. Kel l y ’ s b add eb td edu ct i o n was el i m i nat edth ro u g h t h e reduct i o n o f t ax at tri b ut es an d h is- 6 1 -

[* 6 1 ] i n s o l v en cy cal cu l at i o n . * * * Infact , S&C co n s i dered rep o rt i n g n ei t h er t h e b add eb td edu ct i o n n o r can cel l at i o n o f d eb ti nco m e, b ecau s e t he t wo es sen ti al l y o ffs eteach o th er o n M r. Kel l y ’ s 2 0 10 retu rn . Ho wev er, as M r. Bru s t k ern t es t i fi ed* * * : “ Wh en we were p rep ari n g t h e ret u rn , we wan t edt o m ak e s u re al l -- fi rs to f al l , we were ju s ttry in g t o m ak e s u re we reco n ci l edal l o u r n um b ers . Bu twe wan t edt o m ak e s u re t h atal l o f t h os e n u m b ers m ad e i to n th e ret urn s o m ewh ere. An d s o we m ad e a d eci s i o n as we were p rep ari ng th e retu rn t o s h o w ev eryt h i n g as far as th e i n co m e an d t he ex p en s e, wh et h er i twas a was h o r n o t . So t h at ’ s wh y th e 9 8 2 h as th e 1 4 5 an d th en t he Sch edu le D h as th e o t h er am o u ntth aty o ureferred t o .” Ul t i m at el y

M r. Kel l y

i s en t i t l edt o th e o ffs et t i n g b ad d eb td edu ct i o n as d i s cu ss edh erei n an dp res en t ed attri al
. W e are u n co n v i n ced b y t h i s l o gi c. Th e b add eb td edu ct io n i s n ota fu n ct i o n
o f t h e al l eg ed COD i n co m e; rat h er i ti s d eb to wedt o M r. Kel l y , n o t b y h i m . Th e

“ zero s u m ” arg u m en ti g no res th e n eedt o el i m i n at e d eb t s b et ween h i s affi l i at ed
co m p an i es . M r. Kel l y ’ s co m

p an i es reg u l arl y

p as s edfu n d s b et ween them . He h as
n o tp ro v en th atth e COD i n co m e o n t h e b us i n es s b add eb t s was p ro p erl y cal cu l at edan d t h at t h e d eb t s were act u al l y o wedt o h im o r b y h i m . Fi n al ly , o u r p ri o r h o l d i n g tran s fo rm s m u ch o f t h e d eb ti nt o d i st ri b u t i o n s i n earl ier y ears wh i ch
m u stb e el i m in at ed
. M r. Kel l y can no tcreat e a d edu ct i o n b y reco rd i n g i n t erco m

p an y d eb tan d th en can cel i ng i t . Th ere m u stb e a d eb to wed t o M r. Kel l y th ati s u nco l l ect i b l e t o creat e a b u s i n es s b add eb t . M r. Kel l y h as n o tes t ab li s h eds u ch d eb tex i s t s o r was
wo rt h l es s i n 2 0 1 0 . Th e p art i es s h al l cal cu l at e t h e am ou n t o f COD i n co m e as p art- 6 2 -

[* 6 2 ] o f t h e Ru l e 1 55 co m p u t at i o n s an dd et erm i n e t h e p ort i o n t h ati s n o t at tri b u t ab l e t o NSI an d i n t erco m p an y tran s fers i n acco rd an ce wi t h o u r h o l d i n g s h erei n . As ex p l ai nedab o v e, atl eas t$ 1 9.3 m i l l i o n o f t h e rep o rt edCOD i n co m e
was u nrel at edt o th e i n t erco m p an y tran s fers . M r. Kel l y

h as n o tes t ab l i s h edth atth e d eb t o w edb y

M OB1 b ecam e wo rt h l es s i n th e am o u n t cl ai m eddu ri ng 2 0 1 0 as M OB1 ret ai n edo wn ers h i p o f t h e o ffi ce b u i l di n g an d cel l t o wer ri g h t s , wh i ch i t l at er s o l d . M r. Kel l y

v al u edth e b u i l d i n g at$ 2 .9 m il l i o n i n h i s i ns o lv en cy cal cu l at io n . V. Tax Val u e o f t h e $ 4 3 ,3 4 4 ,1 2 3 Deb t Di s t ri b u t i o n M r. Kel l y arg u es th atth e d i s t ri b ut i o n o f t he s h areh o l der d eb tan do t her d i s tri b u t i o n s cau s ed by

th e fo rg i v en es s o f s h areh ol d er d eb t i n 2 0 1 0 s h o u ldb e
v al u edatthe fai r m ark etv al u e o f t h e d eb trat h er t han th e face v al ue. Th i s arg u m en ttu rn s o n ch aract eri zat i o n o f t h e d eb tas p ro p erty an dn otas a cas h equ iv al en t . Th i s arg u m en th as n o s up p orti n th e cas el aw o f t h i s Co u rt , wh ich h as
n o taccep t edth e p o s it i o n . InCo m b ri n k v . Co m

m i s s i o n er, 1 1 7 T.C. 8 2 , 9 4 (2 0 0 1 ),
we s t at edthatcan cel l at i on o f s h areh o l d er d eb t “ i s co n si dered th e eq u i v al en to f a d i s tri b u t i o n o f m on ey

i n th e face am o u n to f th e o bl i g at i o n.” In an an al o g o u s
s i tu at i o n , th e as s u m

p t i o n o f s h areh o l d er d eb tu n d er s ect i o n 1 0 01 (b ) i s d eem ed
m o ney recei v edi n th e face am o u n to f t he d eb t . M ah er v . Co m m i s s io n er, 5 5 T.C.- 6 3 -

[* 6 3 ] 4 4 1 , 4 56 (1 9 70 ), aff’ di n rel ev an t p artan d rem an d edi n p art , 4 6 9 F.2 d2 2 5 (8 th Ci r. 1 9 7 2 ). Th e l o gi cal res u l t o f M r. Kel l y ’ s arg u m en two u l d b e t o s up eri m p os e a t es t
o f t h e s h areh o l d er’ s s o l v en cy up o n th e ap p l i cat i on o f s ect i o n 1 .3 0 1 -1 (m ), In co m e Tax Reg s ., an dthe s t atu to ry treat m en t o f s uch a d i s t ri b u ti o n . W e fi n dn o s u ch h u rd le i n the s t atu t e o r t he reg u l at i o n s . Acco rd i n g ly , we h o l dth atth e d i st ri b u t i o n s
cau s ed b y can cel l at i o n o f s h areh o l der d eb tare p ro p erl y s etatth e face am o u n t s o f th e d eb t s can cel ed
. VI. Cl ai m edIn s o l v en cy M r. Kel l y as s ert s thath e was i n s o l v en ti n 2 01 0 an dh i s l i ab il i ti es ex ceed ed h i s as s et s b y

o v er $ 1 5 4 m il l i o n . Acco rd i n g ly , h e as s ert s rel i ef fro m i n cl us i o n o f COD i n co m e refl ect edo n h i s 2 0 1 0 p ers on al retu rn u n d er s ect i o n 1 0 8 (a)(1 )(B). Th i s i s a qu es t io n o f factwh i ch i s co n t es t edi n th es e cas es . Th e rep o rt edCOD i n co m e i s o v ers t at edan ds h o u l db e recal cu l at edo n t h e b as i s o f t h i s o p i n i o n as p art
o f t h e Ru l e 1 5 5 co m

pu t at i o n s. Hi s p ro p o s edcal cu lat i o n o f h i s l i ab i li t i es fo r p u rp os es o f t he i n so l ven cy cal cu l at i o n i n cl u des s o m e l i ab il i ti es o f h i s affi li at ed
co m p an i es wh i ch s h o u l d b e el i m i n at edan ds o m e al l eg ed d eb twh i ch wi l l b e treat ed as d i s t ri b u t i on s o n the b as i s o f o ur p ri o r h o l d i n g . Deb t s du e fro m Kel l y Cap it al an dKel l y

In v es t m en ts are n o t p ro p erl y i n cl u d edi n th e i ns o lv en cy- 6 4 -

[* 6 4 ] cal cu l at i on . M r. Kel l y i n ap pro p ri at el y

i n cl u d ed$ 3 6 ,8 8 8 ,2 54 i n s eco n d ary i n t erco m p an y l o an s . Res p o n d en t ’ s i n s ol v en cy cal cu l at i o n refl ect s l i ab i l i t i es o f $ 8 8,4 6 0 ,8 4 9 , wh i ch rem ov edth e NSI an di n t erco m p an y d eb t
. W e fi n dth i s cal cu l at i o n
co n fo rm s m o re cl o s el y

t o t h e reco rd . It s ho u ldb e u s edas th e s t art in g p oi n tfo r t h e
co m p u t at i o n s u n d er Ru l e 1 55 o f M r. Kel l y ’ s i n s o lv en cy i n 2 0 10 . Neto f an y

d eb t treat ed as d i s t ri b u t i on s o n the b as i s o f o ur h o l d in g h erei n , we ad o p tth i s fi g u re fo r th e n eces s ary

Ru l e 1 5 5 co m

p u t at i o n s t o d et erm i n e wh et h er t h ere i s an y COD i n co m e ex cl u d edfro m g ro s s i n co m e fo r 2 0 10
. Res p o n d en tal s o arg u es th atthi rd -p art y d eb to wedb y

KY&C an dp ers o n al l y g u aran teedb y

M r. Kel l y

s h o u ldb e rem ov edfro m h i s l iab i l i t i es . Su ch d eb ti s ap p ro p ri at e t o co n s i d er as l i ab i l i t y o f M r. Kel l y

wh ere i ti s “ m o re p ro b ab l e t h an
n o tth ath e wi l l b e cal ledup o n t o p ay t h ato b l i g at i o n i n t h e am o u n tcl ai m ed ”. M erk el v . Co m

m i ss i o n er, 1 0 9 T.C. 4 6 3 , 4 8 4 (1 9 9 7 ) (es t ab l i s h in g a l i ab i l i t y o n th e b as i s o f a p ers on al g u aran t y ), aff’ d , 1 9 2 F.3 d8 4 4 (9 t h Ci r. 1 9 9 9 ). M r. Kel l y p ers o n al l y

en t eredi n t o th e l o an ag reem en t s fo r t h e th ird -p art y d eb tt o g et h er wi t h h i s two wh o l l y

o wn ed LLCs , Kel l y

Cap i t al an dKY&C. Th e d eb t was ev en tu al l y p ai di n fu l l. W e fi n dthatM r. Kel l y h as es t ab l i s h edthatas o f 2 0 1 0 h e wo ul db e req u i redt o p ay

th e l i ab i l i t y . Li k ewi s e, h e rem ai n edl i ab l e fo r t h e rem ai n i n g $ 8
. 8- 6 5 -

[* 6 5 ] m il l i o n l o anb al an ce o n th e b as i s o f h i s p ers o nal g u aran t y aft er Vi rtu co n
s u rren d eredth e ai rp lan e i n p art i al s at i s fact i o n o f t h e b an kd eb tan d s at is fi edth e M erk el s tan d ardfo r th i s l i ab il i t y . M r. Kel l y h as al s o es t ab l i s h ed h is l i ab i l i t y fo r IHSD’ s $ 6 2 m il l io n
co n st ru ct i o n l o an . Res p o nd en ts u gg es t s o n b ri ef t h at t h e d eb ts h ou l dn o tb e treat ed as a l i ab il i ty

o f M r. Kel l y

b ecau s e o f t he An d az Ho t el ’ s ag reem en tt o m ak e p aym en t s o n th e d eb tfo r a l i m i t edt i m e. Ho wev er, res p on d en t ’ s i ns o l v en cy cal cu l at io n o n b ri ef i n cl ud es $ 5 0 m i l l i on o f t h e co n s t ru ct i on l o an as a l i ab i l i t y o f M r. Kel l y , wh i ch we treat as a co n ces s i o n b y res p o n d en t . Fu rt h erm o re, we fi n d th atth e d eb ti s a l iab i l i t y

o f M r. Kel l y

u n d er t h e M erk el s t an d ard . W e d i s m i s s
res p o n d en t’ s o b

ject i o n s t o o t h er l iab i l i t i es l i s tedi n M r. Kel ly ’ s i ns o lv en cy cal cu l at io n i n cl u d i n g h i s cred itcardd eb t
. Res p o n d en tal s o ch al l en g es M r. Kel l y ’ s cal cu l at i o n o f h i s as s et s , ap p ro x i m at el y $ 7 0 m i l l i o n . Res p o n d en tch al l en g es the v al u e t h ath e as s i gn edt o h i s cars , h i s p ers o n al res i d en ces , Gas l am p Part n ers , h i s o wn ers h i p i n t eres ti n IHSD, an dKY&C’ s y ach t . W e fi n dth at M r. Kel l y h as es t ab l i sh edth e v al ues p l aced o n t h es e as s et s ex cep t fo r t h e y ach t . Res p o n d en tp l aced a v al u e o f $ 5
m i l l io n o n th e y ach t, wh i ch we fi n db et ter refl ect s i t s fai r m ark etv al u e i n th e l i g ht- 6 6 -

[* 6 6 ] o f t h e p u rch as e o ffers th atKY&C recei v edfo r t h e y ach ti n l at e 2 0 1 0 an d earl y 2 0 1 1 o f $ 5 .3 m il li o n t o $ 8 m i l l i o n. Res p o n d en tal l eg es th atM r. Kel l y o m i t t edh i s o wn ers h i p o f Vi rtu co n ’ s ai rp l an e, a $ 68 0 ,5 3 7 t ax refu nd , an dh i s o wn ers h i p i n teres t s i n 1 4 affi l i at ed
co m p an i es i n cl u d i n g o n e p u rp o rt ed l y h o l d i n g t ob acco es cro w s . W e fi n dth atth e t ax refu n di s p ro p erl y

i n cl u d edas an as setfo r p urp o s es o f t he i n s o lv en cy cal cu l at io n . Vi rtu co n s u rren d ered t h e ai rp l an e du ri ng 2 0 1 0. Acco rd i ng l y , i ti s n o t
an as s etfo r p u rp o s es o f t h e i n s o l v en cy cal cu l at i o n . Th e reco rdes t ab l i sh es th at M r. Kel l y p ro p erl y i d en t i fi edth e affi l i at edco m p an i es th at co n t i n u edt o h av e an y
v al u e as o f Decem

b er 3 1 , 2 0 1 0 , fo r p u rp o s es o f h i s i n s o l ven cy cal cu l at i o n an dd i d
n o to m i tan y

en t i t i es as al l eg edb y

res po n d en t . Th o s e en t i t i es h ad n o, o r m i n i m al , g ro s s recei p ts o r b u s in es s act i v i t y . Th e reco rdes t ab l i s h es thatan y o m i t t eden t i t i es h ad n o v al ue. Fu rt her, t h e reco rds up p o rt s th e v al u es fo r t h e fo l l owi n g as s et s as
s etfo rt h i n M r. Kel l y ’ s o ri g i n al o r rev i s edi n s o l v en cy cal cu l at i on s : $ 41 ,6 9 7 ,7 0 9 fo r h i s IHSD i n v es t m en t , $ 2 ,0 2 5 ,0 0 0 fo r Gas l am p Part n ers , $ 9 5 0 ,0 0 0 fo r Kel l y Fern l ey , LLC, an d$ 2 ,8 8 0 ,0 0 0 fo r M OB1
. Res p o n d en tas sert s th atth e v al u e o f M r. Kel ly ’ s p ers o n al as s et s o f ap p ro x i m at el y $ 2 .6 m i l l io n l i s t edi n h i s i ns o lv en cy cal cu l at i on s h o u l db e d o ub led t o i ncl ud e M rs . Kel l y ’ s s h are o f t h e as s et s o n the b as i s o f co m m u n i t y p ro p ert y l aw.- 6 7 -

[* 6 7 ] M r. Kel l y o b

ject s t o th i s ad

ju s t m en to n th e b as i s o f h i s p ren up t i al ag reem en t . He arg ues t h at t h ere i s n o co m m u n i t y p ro p ert y . Res p o n d en t ’ s arg u m en ti s p rem i s edo n an al leg at i o n t h atM r. Kel l y d i d n o tl i s tal l o f h is p ers o n al p ro p erty i n h i s s t at em en to f as s et s . M r. Kel l y fai l edt o p ro v id e an i t em i zedl i s to f h i s p ers o n al p ro p ert y

an dth u s can n o ts up p o rt t he v al u e t h ath e as s i gn ed t o h i s
as s et s i rres p ect i v e o f co m m u n i t y p ro p ert y l aws . See Bres s i v . Co m m i s s i o ner, T.C. M em o. 1 9 9 1 -6 5 1 , aff’ d , 9 8 9 F.2 d4 8 6 (3 dCi r. 1 9 9 3 ). Acco rd i n g l y , we accep tthe
v al u e as s ert edb y

res p o n d en to f ap p ro x i m at el y $ 5 .2 m i l l i o n. Res p o n d en tal s o arg u es th atM r. Kel l y h as n o t es t ab li s hedth at FCC an d Green b ackEn t ert ai n m en t were i n s o l v en tas o f Decem b er 3 1 , 2 0 1 0. M r. Kel l y

d i d
n o tad dres s ei t h er co m

p an y ’ s i n s o l v en cy

o n b ri ef an d h as fai l ed t o es t ab li s h th at th ey were i n so lv en t . FCC an d Green b ackEn t ert ai nm en trep o rt ed COD i nco m e fro m th e d i s ch arg e o f i n t erco m p an y d eb t. Th e rep o rt edam o u n to f each en t i t y ’ s COD i n co m e m

u s tb e cal cu l at edi n th e Ru l e 1 5 5 co m p u t at i o n s o n t h e b as i s o f o u r h o l d i n g s h erei n. An y

am o u n to f COD i n co m e s o d et erm i nedd o es n o t qu al i fy fo r
ex cl u s i o n fro m

g ro s s i n co m e u n d er s ect io n 1 08 (a). VII. BadDeb t Du e Fro m Ri ch ard In 2 0 0 9 M r. Kel l y

an d h i s b ro t h er Ri ch ards ep arat edth ei r b u s i n es s
o p erat i o n s . To acco m

p l is h t h e s ep arat io n , M r. Kel l y tran s ferred a p o rt i o n o f- 6 8 -

[* 6 8 ] o wn ers h i p i n t eres ti n TBE t o Ri ch ard , an dKel l y Cap i t al rel eas edRi ch ard fro m l i ab i l i t y fo r a l o an o f $ 1,8 7 1 , 5 1 8 th atRi ch ardo w edt o Kel l y Cap i t al . Kel l y Cap it al ’ s b o ok s refl ect ed$ 3 0 9 , 5 2 9 du e fro m TBE. As p arto f th e 2 00 9 ex ch an g e Kel l y Cap i t al cl ai m ed a b add eb td edu ct i o n o f $ 2 ,6 6 7 ,1 5 3 , wh i ch M r. Kel l y as s ert s i n cl u d es th e $ 1 ,8 7 1 ,5 1 8 d eb tdu e fro m Ri ch ardan dth e $ 3 0 9 ,5 2 9 d eb t du e fro m TBE wh i ch fl o wedth ro u g h t o M r. Kel l y ’ s p ers o n al retu rn fo r 2 0 0 9 as a b add eb t d educt i o n . M r. Kel l y

h as co n ced ed$ 7 2 1,6 6 8 o f t he d educt i on . Th e fact u al i s s u es as so ci at ed wi t h the d edu ct i o n are wh et h er t h e o ri g i n al d eb t was wo rt h l es s , wh et h er t h ere was co n s i d erat i o n p ro vi d ed b y Ri ch ardfo r t h e d eb t fo rg i v en es s , an dwh et h er i twas a g i ftfro m M r. Kel l y

t o get h er wi t h th e TBE
s t ock . M r. Kel l y

h as n o tp ro v enthatth e an s wers t o th es e qu es ti o n s s upp o rtth e d educt i o n , an dwe d o n o ts u s tai n the cl ai m edb ad d eb td edu ct i o n . VIII. Vi rtu co n In t eres tDedu ct i o n fo r 2 0 1 0 Fo r 2 0 1 0 Vi rtu co n d edu ct edan i n t eres tex p en s e o f $ 1 ,6 5 6 ,5 9 7 as s o ci at ed wi th th e s u rren d er o f p o s s es s io n o f anai rp l an e t o Ban k o f Am eri ca. Up o n
s u rren d er, t h e ai rcraft was v al u ed at$ 7
. 5 m i ll i on fo r p u rp o s es o f s et t l i n g Vi rtuco n ’ s d eb t t o Ban ko f Am eri ca. M r. Kel l y co n t en ds th ats o m e p o rt i o n o f t h i s
am ou n twen t t o p ay

i n t eres t b y

referen ce t o a p ro v i si o n i n th e Ban ko f Am eri ca l o an d ocu m en t s thatreq u iredp aym en t s t o b e ap p li ed t o i n t eres tan dl at e fees- 6 9 -

[* 6 9 ] b efo re p ri nci p al
. M r. Kel l y h as n otes t ab l i s h edth atth e ai rp l an e’ s s u rren d er
wo u l dqu al i fy

as a l o an p aym en to r t h ath e m ad e an y p aym en to f i n t eres t
. Acco rd in g ly , th i s d edu ct i o n i s d i s al l o wed
. IX. Yach tEx pen s es KY&C o wn eda y ach twh i ch was th e s ub jecto f d eb t t o W el l s Farg o an da p ro t ect i v e ag reem en tu n d er wh i ch W el l s Farg o i n cu rred$ 2 9 9 ,3 8 8 i n ex p en s es i n 2 0 1 1 . M r. Kel l y

rei m b u rs ed W el l s Farg o fo r t h i s ex p en s e, an dth e d edu ct i o n o f th i s ex p en s e i s s u st ai n ed . Vari o u s o t h er ex p en s es are i n d i sp u te, an d o n t h e b as is
o f t h e t ri al reco rd we s u s t ai n th e ex p en s es d educt edwi t h th e ex cep t i o n o f $ 2 1 ,8 4 4
o f car an dtru ckex p en s es fo r 2 0 1 0 an d$ 2 7 , 8 7 4 o f d ep reci at i on fo r 2 0 1 1
. X. LBHo ri zo n s Ex pen s es Fo r 2 0 1 0 res po n d en td i s al l o w edco s to f g o o d s s o l do f $ 5 ,0 0 4 ,2 00 an do t h er
ex p en s es rel at edt o LBHo ri zo n s ’ co n d o p ro ject
. He co n ced es th atM r. Kel l y i s
en t i t l edt o th e $ 5 ,0 0 4 ,2 0 0 ad ju s t m en tfo r th e co s to f g o o ds s o ld . Onthe b as i s o f th e reco rd , we fi n dth atM r. Kel l y h as p ro v en th atth e o t h er ex pen s e d educt i o n s at i s su e were p ro perl y

refl ect ed o n h i s 2 0 1 0 p ers o n al return . XI. Pas s iv e Act i vi ty

Lo s s M r. Kel l y d educt edcu m

u l at i v e p as s i v e l o s s es rel at edt o FSIF an dRad i u s M o rt g ag e fo r 2 0 1 0 . He as s ert s th atFSIF was ab an d o n edi n 2 0 10 . W e fi n dth at- 7 0 -

[* 7 0 ] M r. Kel l y h as es t ab li s h edth e am o u n t o f t h e l o s s cl ai m edat t ri b u t ab l e t o FCC
an d i s en t i tl edt o d edu ctth e l o ss . Ho wev er, t h e reco rds upp o rt s a fi n d i n g t h atFCC h ad act i v i t y

i n t o 2 0 1 1 , an d we al l o w th e l o s s fo r t h aty ear. Res p o nd en targ u es th at M r. Kel l y h as n ot es t ab l i s h edh i s b as i s i n Rad i u s M o rt gag e o r t h e am o u n tatri s k th erei n o r t h atth e l o s s was i n cu rredi n th e n o rm al co u rs e o f b u s in es s . Onth e b as i s
o f t h e reco rdM r. Kel l y

h as es tab l i s h edth ath e i s en t i t l edt o th e carry ov er l o s s , an d th e d edu ct i o n i s s us t ai nedt o t h e ex t en tal l o w ab l e i n th e Ru l e 1 5 5 co m p u t at i o n s . XII. Ban kDep o s itAn al y ses Fo r 2 0 1 0 an d2 01 1 res po n d en tp erfo rm edan al y s es o f b an k d ep os i t s i n t o Kel l y Cap i t al ’ s acco u nt s an dd et erm i n edth atKel l y Cap i t al h adu n rep o rt edg ro s s recei p t s fo r b o t h y ears . W e ag ree wi t h M r. Kel ly th atth es e u n rep o rt edi n co m e ad ju s t m en t s dup l i cat e res p o n d en t ’ s b as i c p o s i t io n th at l o an s th atfl o wed fro m Kel l y Cap i t al t o M r. Kel l y

were d i s t ri b u t i o n s. W e h av e s us t ai n ed res p on d en to n th e d i s tri b u t i o n ad

ju s t m en t s fo r 2 0 1 0 an d2 0 1 1 an dfi n dth atres po n d en t h as fai l ed t o es t ab l i s h , t o the ex t en th e h as n o to th erwi se co n ced ed , thatth e b an k d ep o s i t
an al y s es d o n o tdup l i cat e th e d i s t ri b u t i o n ad ju st m en t s . In reach i n g o u r h o ld in g s , we h av e co n s i dered al l arg u m en t s m ad e, an d , t o th e ex t en tn o t m en t io n ed ab o v e, we co n cl u d e t h ey are m o ot , i rrel ev an t , o r wi t h o u t
m eri t
.- 7 1 -

[* 7 1 ] To refl ectthe fo reg o i n g , Deci s i o n s wi l l b e en t eredu n der Ru l e 1 5 5
.