Case study of legal and accounting costs during major IRS audit

Update 2/19, 6 p.m. – Earlier today I received a reply from Food for the Hungry sharing some background information with me.  They will look at this post in more detail and get back to me.  I will share with readers whatever additional information the organization wishes to share.

Update:  IRS audit has been resolved.

A charity going through a major dispute with the IRS has incurred a lot of costs dealing with an audit.

After seeing two sets of financial statements and 990s that were restated last fall (yes, yes, I’m a little slow on the uptake), I thought about checking to see if the Food for the Hungry financials have been restated. Checked the New York AG web site and didn’t see any revisions.

I would like to use the Food for the Hungry financial statements as a case study of the costs incurred from getting involved in a tax or legal dispute.

After looking at a large number of financial statements over many months, I’ve realized that sometimes a specific set of financial statements will clearly illustrate some point that is under discussion. Many other charities may have the same thing happening, but it is not really visible on the surface of the financials.

When something can be clearly seen in one charity, I will write about their financials in order to illustrate the larger concept. This isn’t to pick on one charity or another. The issues discussed are probably present in other charities.

When I looked at the FH financials, I realized they would show the cost of fighting a major IRS audit.  FH is large enough and dealing with a serious enough audit to actually have visible legal and accounting costs. At the same time, they are small enough to actually see the impact.

So, with that meandering introduction, I’d like to look at the legal and accounting costs incurred that appear to be related to the IRS audit of FH. In a later post I will explain why I’m looking at these financials as an extremely rough proxy for explaining it is a really good idea to stay out of legal disputes. Avoid court if at all possible.

Costs to dispute a major IRS audit

In January 2012, news broke of a major IRS audit of FH’s 990 filing for 2008. The IRS claims the donated medicines were substantially overstated. The audit indicated the 2008 filing should be amended to reflect correct values and asserted a $50,000 penalty should be paid.

Although there are multiple issues involved, seems to me that the central point is the valuation of gifts-in-kind, particularly mebendazole.

FH has strongly disagreed with the IRS findings and is disputing the facts and conclusions in the agent’s report, according to several visible comments and media reports.

During 2011 and 2012, it looks to me like FH incurred over $200,000 of accounting and legal costs to deal with the IRS audit. The 2013 990 obviously hasn’t been filed, so information for ’13 is not yet public.

You can find several years of financial statements and 990s at the New York Attorney General’s website here. The link is http://www.charitiesnys.com/RegistrySearch/show_details.jsp?id={90451CC9-90AE-4A3F-B862-42679075254E}

Here is the amount of legal and accounting costs disclosed on FH’s 990s for the last 6 years:

FY	legal	acctg	combined	change
2007	15,115	68,443	83,558
2008	9,108	72,720	81,828	(1,730)
2009	3,882	72,126	76,008	(5,820)
2010	15,767	74,125	89,892	13,884
2011	16,865	175,648	192,513	102,621
2012	28,158	168,460	196,618	4,105

The IRS audit went public in January 2012. Indications I’ve seen suggest the audit was in ‘11. It is my conclusion the increase in legal and accounting costs in ‘11 and ‘12 are related to addressing the audit.

Request for comment

I reached out to FH and their media consultant on February 5 asking for comment on this article. I also asked if there is some other reason for the increase in legal and accounting expenses other than dealing with the IRS audit.

On February 6th, I received a reply from the media consultant indicated the ministry would get back to me with comments. I have not heard anything else in two weeks. If FH provides a comment I will update this post.

Accumulation of costs

Let’s drill down further in the 990.

Here are the legal costs by functional category for the last four years. The costs listed are those allocated to program, general & administrative, and fundraising.

 

	legal
	prog	g&a	F/r
2009		3,882
2010	1,000	8,987	5,780
2011	1,491	12,824	2,550
2012	500	27,658

 

The fluctuation from ‘09 to ’10 looks like the typical variation from year to year. The increase in program and G&A in ’11 and ’12 is probably related to dealing with the IRS audit.

Using ’10 as a baseline, legal costs categorized to program and G&A were higher by $4,328 in ’11 and by $18,171 in ’12.

That relationship makes sense since public comments indicate legal counsel was retained about the time the IRS audit report was issued to FH. Some costs would have likely been incurred before, but the larger fees would reasonably have been in ’12.

Here are the accounting costs for the last four years allocated by program, G&A, and fundraising.

 

	accounting
	prog	g&a	F/r
2009	7,000	65,126
2010		74,125
2011	94,115	81,533
2012	90,360	78,100

 

The fluctuation in costs from ’09 through ’12 for G&A looks like the typical variation in audit costs for an organization of this size. Most notable is the costs allocated to program. Sure seems obvious to me that would be the accounting fees paid to assist with addressing the IRS audit.

Large hours would have been incurred in ’11 to gather and present information as well as interact with the IRS auditor. Large hours would have been incurred in ’12 responding to the statements in the IRS audit report.

My inference would then be that $94,115 of accounting fees in ’11 were related to the IRS audit as well as $90,360 of accounting fees in ’12.

That means the external costs for addressing the IRS audit, not including the cost of substantial time by FH staff, would be approximately:

• $  22,499 – increased legal fees in ’11 and ‘12
• $  94,115 – accounting fees in ‘11
• $  90,360 – accounting fees in ‘12
• $206,974 – estimated costs in ’11 and ’12 to address IRS audit

When the ’13 financial statements and 990 are released later this year, I’ll update this tally.

If Food for the Hungry provides any comment, I’ll update this post. Immediately after publishing this post, I will again ask FH for comment.

What do you think? Did I misread something? Misunderstand some detail? Make a bad assumption?

Full disclosure:

It’s been a while since I discussed Food for the Hungry. Would be a good idea to repeat a few disclosures:

Capin Crouse is the current auditor for Food for the Hungry. They have been the auditors for a long time.  I worked for Capin Crouse from 1989 through 2002. Media reports elsewhere have mentioned the name of the audit partner on the engagement.  During the time I was employed at Capin Crouse, the audit partner on the FH engagement for some portion of the time mentioned in this post as well as Mr. Barry Gardner (current CFO of FH) were colleagues of mine at the firm.  During the mid or late 1990s, I worked on the Food for the Hungry audit for a small number of hours.  Finally, since sunshine is a good thing, it is also worth noting that my firm (Ulvog CPA) and Capin Crouse are competitors in providing services to the nonprofit community.

That info will allow you to interpret my post as you wish.

Next post: Please try to stay out of court

Update:  See update comment at start of post.