In August of 2011 CharityWatch published The Alice in Wonderland World of Charity Valuation, in which we described a serious problem among many charities that raise and distribute non-cash aid called gifts-in-kind (GIK). Charities are responsible for determining the value of the GIK they receive, and many have unfortunately chosen to inflate these values to levels that far exceed what the same items would cost had they been purchased by the charity rather than donated to it. The dollar values a charity assigns to its GIK are then mixed together with its cash revenue and expenses in its financial reporting, often making the nonprofit appear to be larger and operating more efficiently than it actually is.

Shortly after CharityWatch published our in-depth article on this widespread problem in the nonprofit sector, the IRS asked at least one charity, Food for the Hungry (FH), to verify its GIK valuations. A letter sent by the IRS to FH gives donors a rare opportunity to peer through the looking glass and see details that are too often hidden from public scrutiny. Note: The letter provided to CharityWatch has FH's name and some other names redacted and does not include attachments. FH declined CharityWatch's request for a complete copy of the letter it received from the IRS.

In its January 2012 letter, the IRS accuses FH of purposely misleading the public and the IRS so that it could raise more funds, and instructs the charity to amend its fiscal 2008 tax filing to devalue its GIK from the $75.7 million it originally reported to just $92,633. The IRS also levied a $50,000 penalty against FH and said that managers of the charity could face additional penalties if they fail to correct the group's fiscal 2008 tax filing. FH says in an official statement that its tax form was accurate and told CharityWatch that it strongly disagrees with the IRS's findings as of January 2012 and "will be cooperating to resolve this matter with the IRS over the next year."

Barry Gardner, FH's Chief Financial Officer, told the Chronicle of Philanthropy that "The values that we claimed were in accordance with then-prevalent tax law and generally accepted accounting principles." He indicated that newer accounting rules that caused the charity to devalue its Mebendazole deworming pills from $10.64 to $1.54 per tablet in later reporting years did not yet apply when FH filed its fiscal 2008 tax form.

CharityWatch believes that FH and many other international aid charities were violating the spirit of the accounting guidance by valuing their GIK at many times more than the cost at which these goods could be purchased from multiple sources. While new accounting guidance has helped to restrict certain, very extreme overvaluations, the underlying problem of charities inflating the value of their GIK persists. For example, even FH's reduced $1.54 per tablet valuation of its Mebendazole pills is still 77 times the two cent per tablet price at which it can be purchased from multiple sources.

FH currently advertises on its own web site that it can provide an individual with a year's supply of deworming pills for as little as five cents. FH told CharityWatch that the 5 cents cited on its web site refers to "all costs associated with supplying two doses of Albendazole [deworming medicine] to one child for one year." This amounts to 2.5 cents per tablet which is 56 times the $1.40 per tablet value that FH said it used in its recent financial statements.

CharityWatch has previously reported that one way charities inflate contributions is by magically turning a purchase into a donation. Some nonprofit executives have explained off-the-record how it can be done: Charities like to receive donations of certain types of products whose values are easy to inflate. When a charity is not successful in soliciting donations of such products in large volumes directly from donors or companies, it will purchase them instead. The charity will then claim that what they paid for these products was simply a "handling fee" and that the products themselves were donated. Of course, these supposed "handling fees" often exceed what a person would pay on the open market to purchase the goods in question. By calling these transactions "donations" instead of purchases, the charity is freed up to hugely inflate the value of these products in its financial reporting.

After reviewing emails between FH and commercial vendors of pharmaceuticals, the IRS alleges that before FH purchased medicines it required the vendor to provide a donation letter and documentation describing the sales or acquisition costs as "fees." The IRS letter alleges that, "eager to make a sale," the drug vendor "was willing to provide whatever documents [were] requested in order to facilitate the sale." For example, the IRS refers to one email to a vendor showing that FH was to pay only $35,000 for deworming medicines that it wanted to value at $21.3 million for financial reporting purposes.

The IRS asked FH to subtract $46.4 million of claimed deworming pill donations from its total income and expenses on its fiscal 2008 tax form. It is FH's position, according to the IRS letter, that all of the deworming pills in its 2008 tax form were properly documented donations rather than purchases and that any fees paid to vendors were "handling or service fees." In addition, according to the IRS letter, FH said that its accounting firm reviewed full documentation on the GIK, including the valuations, and gave the charity a clean audit opinion.

The IRS also accuses FH of incorrectly taking credit for another charity's distribution of GIK aid. For example, FH reported as income and expense the full $1.6 million value of GIK that Project Hope in Virginia sent to its personnel in Nicaragua even though FH "was involved only to the extent that [it] was paying for the shipping costs and arranging for the shipping," alleges the IRS.

The IRS letter alleges that FH overvalued its GIK in order to claim in its fundraising materials that it "could multiply any donations it received; for example it could make grants of $21 for every dollar donated…" Other aid charities make similar claims. For instance, World Vision currently states in bold on its web site: "Your gift, in partnership with supplies from top pharmaceutical companies, multiplies 12 times…" It also allowed FH to appear better in rankings of charities that utilize efficiency and overhead measurements, according to the IRS letter. Note: FH's GIK valuations did not improve its CharityWatch rating since we strip out GIK and "follow the cash" when calculating a charity's financial efficiency.

It is particularly unfortunate that FH would overstate its GIK to exaggerate its income since the charity was a fairly efficient fundraiser during the 2008 fiscal year in question. Once FH's reported $75.7 million in non-cash contributions are subtracted and only cash contributions are considered, its fundraising percentage for that year was relatively low, at 21% of donations raised.

CharityWatch applauds the IRS effort to improve charity accountability by asking FH to amend its tax form. Charities should not be allowed to appear more efficient than they actually are by reporting purchases as contributions, inflating the value of their non-cash donations, or taking credit for other charities' GIK merely because they paid for the shipping costs. CharityWatch believes that these practices are far more widespread than FH, and we encourage the IRS to ask other charities that are exaggerating GIK to correct their tax forms.