IRS Levies Fine on Food for the Hungry Over Drug Valuations

The Internal Revenue Service sent a letter this month to Food for the Hungry, one of the country’s largest aid organizations, alleging that it purposely overstated its revenue from deworming pills 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.

“We believe it is clear that ______ did not file a complete or accurate return,” says the letter. (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 ________ had a purpose to mislead both the public and the Service. _____ did this so it could raise more funds,” the letter says.

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.

The IRS letter gives 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. A second charity has been questioned by the IRS about its valuation practices, according to several nonprofit officials. But that organization has not reported receiving a letter of the sort sent to Food for the Hungry.

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 are split 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 can be higher than the prices paid by nonprofits.

Other accountants and lawyers say charities should record the drugs at their purchase prices—or not count them as donations at all.

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.

Changing Standards

Accounting practices at many aid groups have been evolving. Last year, Food for the Hungry and some 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, called mebendazole, at $1.54 per tablet instead of $10.64.

Mr. Gardner says that under the old guidelines, the $10.64 value was appropriate. He says the IRS seems to be ignoring the fact that the accounting standards in 2008 were different than they are today. “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.

An IRS spokeswoman said privacy laws prevent the agency from commenting.