GAO hits nonprofits for hiding professional fundraising fees

From ANIMAL PEOPLE, July/August, 2002:

WASHINGTON D.C.–Echoing criticisms of IRS disclosure
standards often voiced by ANIMAL PEOPLE, the General Accounting
Office urged a crackdown on misleading declarations of fundraising
expense in a new report formally known as GAO-02-526: Tax-Exempt
Organizations: Improvements Possible in Public, IRS, and State
Oversight of Charities.
“Public watchdog groups have expressed concerns about expense
reporting, and the IRS has found and acted on instances of
inaccurate reporting,” the GAO acknowledged. “However, the IRS has
not assessed, and is just beginning to develop plans to assess, the
extent to which charities are properly reporting expenses.”

All 501(c)(3) charities must annually submit a public
disclosure document called IRS Form 990, if they have $25,000 in
economic activity or assets during the year. However, the IRS does
not require all charities to using the same accounting standards.
Therefore the annual ANIMAL PEOPLE “Who gets the money?”
feature published each fall and The ANIMAL PEOPLE Watchdog Report on
Animal Protection Charities, issued as a separate handbook each
spring, include columns separately stating the percentage of budget
spent on fundraising and administration as the charities themselves
declare it, and the percentage that ANIMAL PEOPLE believes to be
more accurate, after applying a uniform accounting standard to all
Form 990 filings that we review.

Concealing costs

“Caution is warranted in using the Form 990 expense data,
especially to compare charities,” the GAO agreed, “because
charities have considerable discretion in recording their expenses in
the program service, general management, and fundraising
categories. Different approaches for charging expenses as well as
different allocation methods can result in charities with similar
types of expenses allocating them differently.”
Added the GAO later in the 76-page report, “Because
efficiency is a criterion that donors may use in selecting among
charities, charities have an incentive to report their expenses in a
manner that makes them appear to be efficient. The IRS has
discovered instances in which charity fundraising expenses have been
underreported because charities have ‘netted’ such expenses against
the funds raised. According to the IRS, fundraising expenses
include fees paid to professional fundraisers as well as in-house
expenses (e.g. salaries) for fundraising.
“For example, a charity might contract with a professional
fundraiser to raise donations. The fundraiser might raise $250,000,
charge the charity a fee of $150,000, and give the charity the
remaining $100,000. When reporting to the IRS, the charity ‘nets
fundraising expenses’ by reporting the $100,000 as a direct public
contribution and does not report the $150,000 retained by the
professional fundraiser as a fee. Such reporting does not comply
with IRS instructions, under which the charity should report the
full amount raised ($250,000) as the direct public contribution, and
[should report] the fee retained by the fundraiser.”
ANIMAL PEOPLE suspects “netting” may be practiced by many
animal protection charities represented by aggressive direct mail
firms. A frequent tip-off to “netting” occurs when an organization
with substantial income declares fundraising expenses to be zero, or
simply leaves a blank line where fundraising expenses are to be
declared.
“A 1999 Urban Institute study of Form 990 expense data found
that 59% of 58,127 charities that received public donations either
reported zero fundraising expense or left this line blank,” the GAO
said. “Using the same criteria as the Urban Institute, our analysis
of Form 990 data from 1994 through 1998 found the number, on
average, to be 64%.”

Misrepresentation

Continued the GAO, “As with netting of fundraising expenses,
the IRS has found that some charities have misrepresented
professional fundraising fees as ‘other’ expenses, but has not
measured the extent to which charities do it.” The GAO noted that,
“The IRS expressly prohibits reporting professional fundraising fees”
as “other” or anything else except what they really are.
“Available data do not show the extent to which charities may
fail to properly itemize their expenses such as for professional
fundraising,” the GAO added, “but charities from 1994 through 1998
reported 26% of all their expenses as ‘other.'”
Coincidentally, ANIMAL PEOPLE found that 26% of the 130 U.S.
animal protection charities whose IRS Form 990 filings we reviewed in
2001 claimed fundraising expense as program service under the
headings of “public education” and “other.”
GAO-02-526: Oversight of Charities was delivered in April
2002 as a “Report to the Chairman and Ranking Minority Member,
Committee on Finance, U.S. Senate.” It may be downloaded at
<www.gao.gov/new.items/d02526.pdf>.