How to Vet a Charity

How to Vet a Charity

Online resources such as GuideStar, Charity Navigator and CharityWatch can help donors scrutinize a nonprofit

By Laura Saunders in the Wall Street Journal

Do you scrutinize your charities the way you do your stocks or mutual funds? You should.

“Charitable giving is a form of investment, and people need to perform due diligence on the groups they give to,” says Ben Pierce, who heads Vanguard Charitable, the $5.1 billion donor-advised fund affiliated with Vanguard Group, which makes donations on behalf of individual account holders.

Now is a good time to take this advice, following the devastating earthquake in Nepal. Disasters always bring out donors’ good intentions—but also charlatans who prey on them. Sandra Miniutti, vice president of Charity Navigator, says traffic to its website tripled to about 100,000 visitors during the week after the earthquake. The site rates 8,000 charities.

A new phenomenon, she says, is appeals from individual “victims” on social media and crowdfunding sites that may be bogus.

Charities are big business. The more than one million nonprofits eligible for tax-deductible contributions—which include many hospitals, universities and private foundations, as well as traditional charities—had revenue of more than $1.7 trillion and assets of more than $3.7 trillion in 2012, the latest data available, according to the National Center for Charitable Statistics in Washington.

Charitable giving from individuals, foundations and businesses totaled $335 billion in 2013, according to the most recent data from the Giving USA Foundation.

The good news for careful givers is that in return for their tax-free status, nonprofit groups other than churches typically must make extensive public disclosures about their finances and governance. Some state authorities require useful disclosures as well.

The result is a wealth of information and analysis available to prospective donors, much of it free and easy to find online. Within minutes you can get data on an organization’s program expenses, fundraising, assets and executive compensation. Groups must even disclose whether someone has “diverted assets”—that is to say, stolen—from them.

Ryan Kirk, a 33-year-old health-care lawyer in New York and a former aid worker in Tanzania, says he and his fiancée use such information to vet groups for their annual donations of several thousand dollars. Too many aid organizations he saw in Africa, he says, “were all hat and no cattle. They had nice SUVs, but it was hard to see what they were accomplishing.”

Like a growing number of givers, Mr. Kirk seeks hard evidence of his charities’ effectiveness. Measuring impact as well as finances is the next frontier of charity evaluation, says Jacob Harold, CEO of the Washington-based GuideStar, which collects data on nonprofits. Some new approaches are largely data-driven, while others rely on expert consensus.

As with other investments, you shouldn’t simply jump at the first opportunity that presents itself. “When someone from a breast-cancer charity calls during dinner, it can be hard to say no,” Ms. Miniutti says.

Here are ways to research charities, plus online resources that ease the task:

Know the nonprofit landscape. The tax code grants exemptions to more than two dozen types of organizations. Exempt groups other than churches must make broad financial disclosures to the Internal Revenue Service annually on Form 990, the tax return for nonprofits. (Churches don’t have to disclose information because of First Amendment protections.)

Nonprofits typically must make their 990 forms available “for public inspection” to everyone—even people who go to their office. Many groups now post their forms online.

Groups known as 501(c)(3) public charities account for the great majority of all nonprofit revenue. The category includes many schools, universities and hospitals in addition to groups such as American Red Cross or United Way. Donations to these groups are tax-deductible, and they must disclose significant donors to the IRS but not to the public.

Private foundations also are classified as 501(c)(3) charities. They typically have fewer donors who exercise greater influence than donors to public charities, but people who give to foundations also face greater limits on tax deductions. Often these donors’ names must be disclosed to the public.

Beware of confusing names. Many groups that call themselves foundations—such as the Bill, Hillary, and Chelsea Clinton Foundation—are in fact public charities, making them subject to public-charity rules rather than the rules for private foundations.

Many nonprofits come in pairs. A political advocacy group such as the National Rifle Association or the Sierra Club will often have a charitable affiliate such as the NRA Foundation or the Sierra Club Foundation. Donations to the charity are deductible, while gifts to the main organization aren’t—in part because of their differing levels of political activity.

Peruse the tax return. Nonprofits with $200,000 or more of annual revenue have to file Form 990, while those with less income often can opt for simplified forms. The 990s are generally available to the public about a year after the end of the organization’s fiscal year—a long lag.

Still, the reports have vital information. Among other things, nonprofits have to give details of their revenue, program costs, assets and expenses. Other questions concern whether the group lobbies, makes political contributions, or has “related-party transactions”—which would be the case if, say, the group is renting its space from its CEO.

Tax-exempt groups generally also must list the names and total compensation of their most highly paid employees. Rob Novick, 65, a computer consultant in New York, says he always looks at pay data when deciding which groups to donate to.

“If it’s seven figures, I choose another charity,” he says, “and if it’s more than $500,000, I take a hard look.”

Pay information can show interesting details. At Northwestern University, for example, the head football coach has been one of the most highly compensated employees in recent years. On the 2012 Form 990, his $2.2 million pay outranked that of all other employees.

Look beyond IRS filings. Many charities publish annual financial reports in addition to filing 990s with the IRS. Daniel Borochoff, who heads CharityWatch, an evaluation group based in Chicago, likes to review the reports, but prefers they be audited. “It means an outsider has verified the charity’s finances,” he says, whereas the 990 forms often are signed only by the organization’s leaders.

Some states also provide useful information for charitable donors. New York, for example, publishes facts about charities’ sources of government funding that aren’t available on the IRS’s 990 form, says Mr. Borochoff. Massachusetts and some other states ask for details of fundraising activities planned for the future—which is helpful because much 990 information is old.

Piggyback on other analysis. Charity-focused sites provide useful information to donors, but their approaches differ greatly. Charity Navigator applies formulas to information on the 990 form to come up with star ratings for various groups. By contrast, the Better Business Bureau’s Wise Giving Alliance asks charities to answer dozens of questions.

CharityWatch says it draws on a variety of sources to determine how efficiently a charity uses donations, while Philanthropedia canvasses experts in particular fields to recommend charities. GiveWell, a group founded by former hedge-fund analysts, recommends just eight international aid groups that it believes offer outstanding evidence-based results.

Says Mr. Borochoff: “Spending just a little time on research can exponentially increase the good works accomplished by a donation.”