Jerry S. Payne - Page 6

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               During the audit years, petitioner owned and operated, in              
          Houston, Texas, a law firm under the name of Payne & Associates.            
          Petitioner’s law practice primarily involved civil litigation.              
          Through Payne & Associates, petitioner was self-employed as a               
          lawyer and in real estate development.  He reported his income              
          and expenses from those activities, on a cash basis, on Schedule            
          C attached to his individual returns.  Petitioner was also a 50-            
          percent shareholder in Payne & Potter, Inc., a real estate                  
          development corporation that was insolvent by the end of 1986.              
          Petitioner’s Involvement With and Acquisition of the Stock of               
          2618, Inc.                                                                  
               Prior to and during the audit years, 2618 owned and operated           
          a topless dance club in Houston, Texas, under the name of                   
          Caligula XXI (the club).  From 1986 through 1988, petitioner                
          represented 2618 and the club in litigation against the city of             
          Houston and others arising out of the city’s denial of the club’s           
          application for a permit to conduct a sexually oriented business            
          (the SOB permit), and against the Texas Alcoholic Beverage                  
          Commission (TABC) for its refusal to renew the club’s mixed                 
          beverage permit permitting the sale of alcohol to patrons.                  
          Petitioner also provided legal representation to Gerhard Helmle             
          (Helmle), one of the two 50-percent shareholders of the stock of            
          2618, in criminal proceedings against Helmle for the possession             
          of illegal drugs.  Prior to and during the audit years, Helmle              
          was involved in managing the operation of the club.                         

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