The Internal Revenue Service has concluded that more than 30 credit-counseling firms -- accounting for more than half of the industry's revenue -- are not entitled to tax-exempt status.
Five firms, mostly small ones, have already had their tax-exempt status revoked, while the rest have been notified of the agency's intention, according to the agency.
The proposed and final revocations are the results so far of 60 audits the IRS has been conducting for more than two years into credit-counseling organizations. The audits were prompted by hundreds of consumer complaints of deceptive business practices, including high fees, high-pressure tactics and inadequate educational services. The IRS has been trying to determine if credit-counseling agencies were misusing their tax-exempt status to take advantage of financially strapped consumers.
Steven T. Miller, commissioner of the IRS's tax-exempt and government entities division, said the agency is seeking revocations for a combination of reasons. In some cases, "we do not believe they are providing sufficient education to the debtor," he said. "Or regardless of what they are providing, too much money is being siphoned out of these organizations and going into the pocketbooks of the CEOs and for-profit affiliates."
To date, none of the credit-counseling agencies under review has been given a clean bill of health. However, Miller said, "I think some of them, as we continue, will pass muster."
The firms can appeal the proposed revocations, but, if they do take effect, "that doesn't mean we're closing their doors," Miller said. It means "they are a taxable entity and are responsible for income tax like any other corporation."
However, in eight states, including Maryland, credit-counseling groups are required to be tax-exempt to be able to offer their services.
Prices to rise?
Industry officials say the revocations could affect the economic viability of many entities because much of their funding is dependent on their tax-exempt status. About half of the industry's funding comes from banks and credit card issuers that pay the counseling firms a percentage of money recovered through repayment plans drawn up by counselors. Up to now, most banks have insisted that the counselors be tax-exempt to receive the funds, called "fair share" in the industry.
"The basis by which we survive are grants and fair-share contributions," said John C. Gormley III, head of Consumer Credit Management Services. "To the extent they are not available, they will have to be offset by the consumer," said Gormley, whose firm was notified Friday that it was about to be audited.
The IRS action comes at a critical time for the credit-counseling industry, which has been given a new, central role in the nation's bankruptcy system under changes that went into effect last October. The new bankruptcy law, designed to make it harder for consumers to wipe out their debts, requires consumers to consult with an approved credit-counselor course before they may seek protection from creditors in bankruptcy court.
The proposed revocations raise concerns about whether there will be enough counseling firms to provide that service. No one knows for sure because the IRS, under law, may not identify firms it is auditing, even to another government agency. The Justice Department's U.S. Trustee Program, which oversees the nation's bankruptcy courts, decides which credit-counseling agencies can give pre-bankruptcy advice.
'It's going to get messy'
It is unclear whether the large national credit-counseling firms that are currently advising thousands of debtors a month could be affected.
"Hopefully, there's no overlap, because it's going to get messy," said Samuel J. Gerdano, executive director of the American Bankruptcy Institute, a nonprofit education and research group.
Washington attorney Jeffrey S. Tenenbaum, who represents about 50 credit-counseling agencies, said he was not surprised at the number of proposed revocations and predicted more to come. But, he said, it was frustrating that the IRS has not yet given any counseling group a green light or issued guidelines on what groups must do to retain their tax-exempt status. "At a time when credit counseling has been endorsed by Congress and is now mandatory prior to filing for bankruptcy, the industry is operating in the dark as to what the IRS's tax-exemption standards are. This has created great instability in the industry."
Unless a firm announces that its tax exemption has been revoked, the only way for the public to know is through the revocation listings that the agency periodically posts. Last year, the agency revoked tax exemptions for A Better Way Credit Counseling Inc. and Gibson Trust Inc., both of Florida; National Consumer Council Inc. of California; National Credit Education and Review of Michigan; and the National Center for Debt Elimination of Pennsylvania. Most of these have closed their operations or sold their accounts to other firms. One of the agencies, the National Center for Debt Elimination, is no longer accepting new customers. President David Leuthold said the company was mistakenly set up as a nonprofit, so "we welcomed the revocation of tax-exempt status."