News and analysis
February 01, 2012

Update: IRS Levies Fine on Food for the Hungry Over Drug Valuations

Editor's Note: This article updates a previous story published on Jan. 30.

The Internal Revenue Service sent a letter last month to Food for the Hungry, one of the country’s largest aid organizations, alleging that it purposely overstated its revenue from deworming pills and other goods in 2008 with the intention of misleading would-be donors.

The letter levies a penalty of $50,000 on the charity. It says that charity managers could face additional financial penalties if the organization does not correct its 2008 tax filing.

The letter says “_____ did not file a complete or accurate return.” (The organization’s name was redacted from a copy of the letter provided to The Chronicle, but an official of Food for the Hungry confirmed the charity’s identity.)

“The fact that _____ took actions to document incoming and outgoing donations that ______ should not have been reported on its Form 990 and actually misreported those donations on its Form 990 indicates that ______ had a purpose to mislead both the public and the Service. _____ did this so it could raise more funds,” the letter says.

All told, the IRS letter says, Food for the Hungry’s noncash contributions should have been listed on its 2008 tax form as $92,633, not $75.7-million.

Food for the Hungry contests the IRS’s claims.

“The values that we claimed were in accordance with then-prevalent tax law and generally accepted accounting principles,” said Barry Gardner, Food for the Hungry’s chief financial officer.

Mr. Gardner said the organization has retained a lawyer, Charles M. Watkins, who specializes in nonprofit issues.

A New Focus

The IRS letter gave Food for the Hungry until January 31 to respond, but Mr. Gardner said his charity had received an oral assurance that the deadline had been postponed.

The letter could signal broader IRS interest in charity drug values. Mr. Gardner said the IRS informed him and Mr. Watkins that the agency had created a “task force” to examine the issue.

Mr. Gardner said a second charity had been questioned by the IRS about its valuation practices, but he declined to name the organization.

An IRS spokeswoman said privacy laws prevent the agency from commenting. The agency’s 2011 agenda says that it has an effort under way to examine charities that are involved in “gifts-in-kind,” or noncash, donation programs.

State regulators are also looking into nonprofit groups’ valuation practices and the companies and organizations that supply goods to them.

Controversial Practices

How humanitarian groups value their medicines has been a source of controversy. Lastfall, The Chronicle reported on the widespread practices of aid groups paying 2 cents a pill for deworming tablets but valuing those medicines as high as $16.25 per pill.

The practice made some aid groups look on paper as though they were much larger than they were, sometimes by tens or even hundreds of millions of dollars.

Accountants disagree on whether charities may purchase drugs and then mark them up to higher values. Accountants who sign off on the practice say it is permitted because the drug suppliers have “donative intent,” or a desire to make a gift, and that commercial prices for the drugs are higher than the prices paid by nonprofits. Some groups say the payments to drug suppliers are handling fees, not payments for the drugs themselves.

Other accountants and lawyers say charities are paying for the drugs, and they should not be booking them as donations.

The IRS letter clearly sides with the latter position. The letter disputes the charity’s claims of “donative intent.” The IRS says Food for the Hungry should not have counted any of the $46.4-million revenue it claimed from deworming pills.

It says e-mails show that Food for the Hungry officials knew that they were buying medicines and sought paperwork that described any money paid as handling fees so they would be able to record the transactions as donations.

Mr. Gardner, who joined the charity in 2010, rejects that characterization. “The extensive correspondence [the IRS agent] reviewed should have been proof of the lengths we went to establish what the accurate donative value was,” he said.

The IRS letter also takes issue with other noncash revenue claimed by Food for the Hungry, saying that the charity claimed the value of goods to which it did not have title. Mr. Gardner says the IRS’s interpretation of the transactions is wrong.

Changing Standards

Accounting practices at many aid groups have been evolving. Last year, Food for the Hungry and many other nonprofit aid groups reduced the values they place on the deworming pills and other drugs, a move they said was prompted by a new rule from the Financial Accounting Standards Board, which provided additional guidance on how nonprofits and companies should value their products. Food for the Hungry is now valuing one type of deworming pill at $1.54 per tablet instead of $10.64.

Mr. Gardner says that under the old guidelines, the $10.64 value was appropriate. “Regardless of what current law and standards might be, [Food for the Hungry] was in compliance with those that applied when we filed our tax return.”

Gregg Capin, an accountant whose firm audited Food for the Hungry in 2008 and in later years, says the Internal Revenue Service seems to be overreaching.

“I take issue with the IRS attempting to set or interpret generally accepted accounting principles,” he said.