An Administrative Law Judge has held that a married couple’s claimed charitable deduction should be denied as unsubstantiated, and that various amounts reported as wages and income to the husband should be included in his taxable income. Matter of Rabbi Milton Balkany and Sara Balkany, DTA No. 823424 (N.Y.S. Div. of Tax App., Nov. 13, 2014).

Facts. With regard to the deduction, Rabbi Balkany and his wife reported a charitable deduction of $500,000 for 2005, the year in issue, although the Balkanys themselves did not make the charitable donations, and the payments were not made directly to a qualifying charity. The Balkanys claimed, first, that approximately $420,000 was paid to vendors, employees, and creditors of Bais Yaakov, a religious school that qualified as a charitable organization under Section 501(c)(3) of the Internal Revenue Code, by their son, Levi Balkany, for the benefit of Bais Yaakov. They also claimed that a third party, Rite Surgical Supplies, Inc. (referred to as “Rite Care”), a company 50% owned by Levi, paid amounts to Levi that were in fact owed to Rabbi Balkany as compensation for his business connections that had resulted in substantial revenue for Rite Care. Levi then remitted the funds to the creditors and not to Rabbi Balkany because the Rabbi did not always have a bank account in which to deposit the money.

Rabbi Balkany also challenged the inclusion of two items of income that had been reported to the IRS. Bais Yaakov, where Rabbi Balkany taught, had reported that he had received $180,000 in wages, but Rabbi Balkany claimed that he had foregone $80,000 of that amount to allow the school to pay its debts, and that the $80,000 formed part of the $500,000 charitable deduction. He also argued that, although Rite Care had issued a Form 1099 reporting the payment of approximately $420,000 to him as miscellaneous income, the Form 1099 was issued in error, because it did not represent income to him but rather payment for the school’s debts. He claimed that, while initially Rite Care had directly written checks covering the school’s expenses, because these expenses had nothing to do with Rite Care’s business, Levi’s business partner believed it was better to place the funds into Levi’s account. Levi then issued the checks to the school’s creditors, but since Levi was merely a conduit, the Form 1099 was issued to Rabbi Balkany.

On their 2005 federal return, the Balkanys had claimed the same $500,000 charitable deduction. They benefitted from the Katrina Emergency Tax Relief Act of 2005 which, among other benefits, temporarily modified the rules relating to charitable deductions by removing the usual 50% contribution base limitation, allowing greater deductions to be claimed. New York had not adopted this federal provision into the Tax Law. The Balkanys provided a letter from the IRS indicating abatement of a tax assessment, and although the Balkanys were provided additional time after the hearing to submit further documentation of their position relating to the IRS review of the charitable deduction issue, no such submission was made. They were also given an opportunity to submit documentation that Bais Yaakov authorized and directed payments to the third parties, but no evidence was provided.

ALJ decision. While accepting some of the legal positions argued by the Balkanys, the ALJ held they had failed to establish the underlying facts. The ALJ found merit in the legal argument that, if a third party (such as Rite Care), owes money to a taxpayer (such as Rabbi Balkany), payments made by the third party, or its designee (such as Levi Balkany), that are debited to the taxpayer’s account, and that reduce the amount owed to the taxpayer, can be treated as having been made by the taxpayer. The ALJ also agreed that the payments need not have been made directly to the charitable organization, noting that in Revenue Ruling 81-110, where individual X made a binding pledge to a charitable organization that was honored by Y, Y is considered to have made a gift to X, and X, but not Y, was entitled to a charitable deduction, because the payment of money or property in satisfaction of an individual’s legal obligation is equivalent to a payment directly to that individual.

The ALJ found several problems with the Balkanys’ arguments and reliance on Revenue Ruling 81-110. Bais Yaakov was not their creditor, but at most a donee, and the payments were not in satisfaction of any binding legal obligation from the Rabbi to the school. The payments did not go from Rite Care to the charity that was allegedly the Balkanys’ creditor, but instead went to Levi, who also did not pay the charity but instead paid others that he claimed were owed money by the school.

However, even if the indirect payments were attributed to the Balkanys, the ALJ held there was no substantiation in the record to support charitable contributions. Many of the checks listed on a check register were unidentified, the register was not contemporaneously prepared, and there was no proof as to where the payments actually went or that they were in satisfaction of the debts of the school. There was no acknowledgment from Bais Yaakov that it received donations or directed payments to creditors or even proof that the amounts were in fact owed to creditors. Observing that “at the end of a tax year with poor records at best, someone attempted to become creative with large sums of income and expenses, and take advantage of the charitable deduction limitation waiver under Hurricane Katrina legislation,” the ALJ determined that the recordkeeping of any charitable contributions was “grossly incomplete,” and the testimony of both the Rabbi and his son was “unreliable and conflicting.”

She also determined that there was no evidence that Rabbi Belkany had actually foregone $80,000 of salary, so that the full $180,000 reported by Bais Yaakov should be treated as his salary. Similarly, she found a complete lack of acceptable evidence that the $420,000 reported as 1099 income from Rite Care was not income to the Rabbi, and held that it was includable in income as well.

Additional Insights

While the trail of payments and alleged motivations in this case were quite complex, the legal principles and applicable rules are fairly clear. Payments made by a third party to pay a binding obligation of a taxpayer may, under the right circumstances, be treated for tax purposes as if they had been made by the taxpayer. However, as in any case involving charitable donations, the record must be clear and well supported by documentary evidence and credible testimony. Similarly, if wages and Form 1099 income have been reported to the federal and state authorities, any attempt to show the reported amounts were incorrect must be firmly supported by documentary evidence. Here, documentary evidence was missing and the ALJ did not find the witnesses credible.