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IRS Credit Counseling Agency Rejection Letters Show the Bulk of the Credit Counseling Industry May Be Put Out of Business in the Near Future

As we reported earlier, the IRS is expected to begin a widespread rejection of credit counseling agencies' (CCAs) "nonprofit" or charitable, tax-exempt status. The American Association of Debt Management Organizations (AADMO) recently shared some of the first publicly released Internal Revenue Service (IRS) letters that state the IRS's rationale for rejecting the tax-exempt status applications of particular credit counseling agencies. Two of the letters, dated earlier this year, contain many identical arguments which suggest the bulk of the entire credit counseling industry could be wiped out by IRS rulings in the near future.

In the two letters, the IRS rejected the applications of two CCAs seeking tax-exempt or "nonprofit" status. The specifics about the CCAs themselves have been deleted from the letters, but the underling principles are left clear. First, the IRS spells out a number of criteria for rejection of tax-exempt status that have been publicly associated with many independent agencies in recent months. For example, the IRS points to a lack of adequate education efforts, close ties between nonprofit agencies and for-profit companies, executive compensation issues and other private-benefit issues that have received considerable public attention in recent months. In addition, the IRS points out that as nonprofits, tax-exempt CCAs are by law exempt from many federal consumer protection laws.

But the IRS letters also point to other legal principles that would also apply to traditional, creditor-sponsored CCAs, such as those affiliated with the National Foundation for Credit Counseling (NFCC) or identified as Consumer Credit Counseling Service (CCCS) organizations as well.

In the letters, the IRS essentially makes the case that the creditor funding and the creditor benefits of debt management plans (DMPs) effectively make credit counseling agencies debt collectors, not charities.

For example, in one letter, the IRS seems to reject the idea that creditor "fair share" payments to agencies are voluntary, instead stating "we view fees paid to you [the rejected CCA] to be in the nature of payments for program-related services." It says the rejected CCA's efforts "substantially benefit the credit card companies to whom your clients owe money because you function as a collection agent for those companies."

The IRS letter notes the Maine Supreme Court, in ruling on the tax status of an NFCC member agency, "denied state tax exemption to a credit counseling agency that provided significant benefit to creditors." The IRS letter later states, "You [the rejected CCA] also provide substantial private benefit to credit card companies in a manner similar to the organization [in the Maine case]. … In the absence of any charitable or meaningful educational activities you are operating as a collection agency for these companies. The ‘fair share' paid by the credit card companies would undoubtedly result in significant savings over the possible costs of not recovering any of the unpaid debt owed them. Thus these companies clearly realize substantial savings through their business relationship with you."

The IRS letter also states: "No court or Service [IRS] ruling has indicated that the sale of DMP's is a charitable activity. Since the sale of DMP's to the public appears to be a substantial purpose of yours, we cannot conclude that you are operating for charitable purposes."

If the principles spelled out in the IRS letter were applied industry-wide, it could have the effect of wiping out virtually the entire credit counseling industry. That's because virtually the entire industry is composed of nonprofit, tax-exempt CCAs which rely heavily on creditor "fair share" funding provided in exchange for servicing DMPs.

The members of the largest credit counseling association, the NFCC, for example, collectively receive two-thirds of their funding from creditors. That funding, as determined by the IRS in these letters, is essentially payment for debt collection services, which it does not consider to be a tax-exempt activity.

Industry-wide application of these principles would have an enormous impact on the credit counseling industry, because it would force CCAs to either largely divorce themselves from creditor funding to retain their tax-exempt status, or become for-profit, taxpaying organizations.

While freeing the industry from creditor control and opening it to financial professionals would be a positive development for consumers in the long run, in the near term it could create serious problems unless most states change their laws governing credit counseling services.

Currently, there is no significant for-profit credit counseling industry in existence. And, a majority of states by law only allow credit counseling to be provided exclusively by nonprofit CCAs or otherwise prohibit businesses and financial professionals from providing credit counseling on a for-profit basis.

Both the industry and most state laws would have to be changed, or credit counseling services won't be available to hundreds of thousands of people seeking credit counseling help to avoid bankruptcy. The loss of access to credit counseling services in a majority of states would have a devastating impact on those consumers, and also result in tremendous economic damage being done to the nation's banks, utilities, retailers and other creditors.

Certainly, the potential impact of these IRS rulings will be a fundamental issue for the credit counseling industry, and for state and federal policy makers to examine as well.

See complete copies of the full letters at:


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