If you're like me, you've received dozens of pleas in the mail from various charitable organizations in the recent past. And I'm sure, being the good Fool that you all are, you do have charity in your heart and want to help as much as possible.

But just as we expect companies that we own to be efficient and effective, we should also expect the same from the charities to whom we contribute. You don't want your charitable dollars going to line the pockets of a handful of executives, nor do you want them going to pay excessive administrative fees.

With the advent of the Internet, it's now easy to know which charities are legit and which do the most good with the funds they are given. Here's what to look for.

IRS seal of approval
Before you make any charitable contribution, make sure the charity is recognized by the Internal Revenue Service (IRS). In order for your contribution to be deductible on your income tax return, the organization must pass IRS muster. The charity must meet at least minimum standards of being a legitimate organization. This doesn't mean that each organization that receives IRS approval as a tax-exempt charity spends its donations wisely. Far from it. But at least you'll know that you'll receive a tax deduction for your contribution.

Remember that not all non-profit organizations are charitable organizations. Many homeowners associations are non-profit, as are many private clubs. But that doesn't mean that you'll receive a charitable contribution deduction when you pay your annual homeowners association dues. So make sure that the organization is truly a tax-exempt charitable organization by visiting the IRS website at www.irs.gov and reading IRS Publication 78. All of the IRS-approved charities can be found there. Since Publication 78 is regularly updated, you'll always have the most recent information at your fingertips.

Making the grade
Once you've determined that the charity is IRS-approved, you might want to see what various watchdog organizations have to say. Many organizations actually rate charities, giving them grades based on various criteria. Two of my favorite charity watchdog organizations are the American Institute of Philanthropy (http://www.charitywatch.org) and Charity Navigator (http://www.charitynavigator.org).

You probably won't find much information on local organizations since only the largest charitable organizations are covered. And also pay attention to the rating system. What might be considered "good" for the rating organization might not necessarily be "good" to you.

Check the tax returns
Your personal tax returns are confidential, and the IRS goes to great lengths to protect your information. But this is not the case for a public charity. Their tax returns are open to public inspection. So why not take a peek and see what the tax return looks like? You can do that by visiting GuideStar (www.guidestar.org). You can easily get snapshot information on more than 850,000 charities. With a more advanced search (which is free, but registration is required), you can actually view the most recent federal tax return (IRS Form 990) in Adobe Acrobat (.pdf) format.

If you review the tax return, pay special attention to Form 990, page 4, part V. This is a list of the officers, directors, trustees, and key employees along with information regarding their salaries, fringe benefits, and expense-account allowances. You might also want to check out Form 990, Schedule A, where you'll find the charity's five highest-paid employees (other than officers, directors, and trustees) along with the five highest-paid independent contractors for professional services.

Also check out the bottom of page 1 of the Form 990. Line 18 shows the profit or loss for the year. Many folks are under the (mistaken) impression that charitable organizations or other non-profits are prohibited from making a profit. That's not the case. In fact, many charities report large annual profits because their income (from donations, fees, investments, etc.) far exceeds their expenses. Is that a good thing? You'll have to be the judge of that. But the more profit generated by the charity, the less those funds are going to the charitable works of the organization.

So, while you're at it, check out part II on page 2 of Form 990. You'll see a Statement of Functional Expenses, which tells how much was spent on program services and for general and administrative costs. See how much is spent on overhead when compared to the actual program services.

Your money, your choice
Charities don't automatically deserve your support. They should earn your support by spending their contributions wisely and efficiently. Use the information here to find a charity that does just that. To learn about some organizations that we Fools think do exceptional work, read about our 2002 Foolanthropy campaign.

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If you like the way Roy Lewis simplifies confusing tax issues, check out his just-published book, The Motley Fool's Investment Tax Guide 2002: Smart Tax Strategies for Investors. This handy 360+ page guide covers just about every tax aspect of a typical Fool's life: investing, marriage, children, education, homes, home offices, retirement accounts, medical expenses, and much more.)

July 18, 2003

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