Service Precedent

The Service addressed credit counseling agencies when they first entered the marketplace in the 1960s. The revenue rulings issued at that time provide examples of a credit counseling agencies exempt under IRC 501(c)(4) and IRC 501(c)(3).

Rev. Rul. 65-299

The Service recognized a credit counseling service (agency) open to the general public as exempt under IRC 501(c)(4) in Rev. Rul. 65-299, 1965-2 C.B. 165. The agency was incorporated as a nonprofit corporation to assist families and individuals with financial problems and to help reduce the incidence of personal bankruptcy. The agency did not limit its services to those in need of such assistance as proper recipients of charity.

The agency:

employed specialists to interview applicants, analyze the specific problems involved, and counsel applicants on the payment of their debts

arranged a monthly distribution to creditors based on the debtor's ability to pay

communicated with creditors and, with the creditors' consent, set up plans which debtors agreed to follow

made its facilities available for debtors to make their monthly pro rata distributions to creditors

made no loans to applicants nor negotiated loans on their behalf

charged nominal fees to cover postage and supplies for its monthly prorating services

charged no fees for the counseling service

relied upon voluntary contributions from local businesses, lending agencies, and labor unions to cover its costs of operations.

Rev. Rul. 69-441

A credit counseling service (agency) was recognized as exempt under IRC 501(c)(3) in Rev. Rul. 69-441, 1969-2 C.B. 115. This agency limited its services to low-income individuals and families with financial problems. Its board of directors was comprised of representatives from religious organizations, civic groups, labor unions, business groups, and educational institutions.

The agency:

provided educational information to the general public on budgeting, buying practices, and the sound use of consumer credit through the use of films, speakers, and publications

assisted low-income individuals and families with financial problems by providing them with individual counseling and, if necessary, by establishing budget plans

serviced the budget plan by allowing the debtor to voluntarily make fixed payments through the agency; holding the funds in a trust account and disbursing the funds on a partial payment basis to the creditors, whose approval was obtained in advance

made no loans to debtors or negotiated loans on their behalf

charged no fees for counseling services or proration services - the debtor received full credit against his/her debts for all amounts paid

relied upon voluntary contributions, primarily from the creditors participating in the organization's budget plans, for its support

The Service distinguished the facts in this ruling from the facts in Rev. Rul. 65-299 that held the organization was exempt under IRC 501(c)(4):

The agency in Rev. Rul. 65-299 was not engaged in any educational activities.

The agency in Rev. Rul. 65-299 did not limit its assistance to a charitable class -- families or individuals in need of such assistance as proper recipients of charity.

CASE LAW:

The Consumer Credit Counseling Service and the Credit Counseling Centers (Agencies) were umbrella organizations made up of numerous individual credit counseling centers. Both had been recognized as exempt under IRC 501(c)(3).

The Agencies provided information to the general public through the use of speakers, films, and publications on the subjects of budgeting, buying practices, and the sound use of consumer credit. The Agencies also provided counseling on budgeting and the appropriate use of consumer credit to debt-distressed individuals and families. They did not limit these services to low-income individuals and families. The Agencies charged a nominal fee of up to $10 per month for some of their services, but waived the fee in instances where payment would work a financial hardship.

The Agencies received the bulk of their support from government and private foundation grants, contributions, and assistance from labor agencies and the United Way of America. An incidental amount of their revenue was from the counseling fees. This was consistent with the fact that only 12 percent of the professional counselors' time was spent on debt management programs as opposed to education. The balance of time was devoted to the educational programs.

The Agencies were controlled by a community board of directors. The boards were required to have at least a 60 percent representation of the general public. The Agencies were not controlled by or the captive of any creditor.

In 1976, relying on Rev. Ruls. 65-299 and 69-441, the Service notified the Agencies that it had made a mistake and was reclassifying them under IRC 501(c)(4). What followed are two pivotal declaratory judgment (IRC 7428) cases: Consumer Credit Counseling Service of Alabama v. United States, 78-2 U.S.T.C. 9660 (D.D.C. 1978) and Credit Counseling Centers of Oklahoma, Inc. v. United States, 79-2 U.S.T.C. 9468 (D.D.C. 1979).

Service Position

The reasons given by the Service for revocation of the IRC 501(c)(3) status were:

the Agencies were not organized and operated exclusively for charitable or educational purposes

the debt management services were not limited to low-income individuals or families

fees were charged for the services rendered.

Courts' Holdings

The courts did not agree with the Service and directed verdicts for the plaintiffs. The courts held that:

Organizations that are charitable and educational in nature are described in IRC 501(c)(3). Providing information regarding the sound use of consumer credit is charitable because it advances education and promotes social welfare within Reg. 1.501(c)(3)-1(d)(2). These programs are also educational because they instruct the public on subjects useful to the individual and beneficial to the community. Reg. 1.501(c)(3)-1(d)(3)(i)(b).

The counseling assistance programs are likewise charitable and educational in nature. Since the community education and counseling assistance programs are the Agencies' primary activities, the Agencies are organized and operated exclusively for charitable and educational purposes.

The debt management and creditor intercession activities are an integral part of the Agencies' counseling function, and thus are charitable and educational undertakings. Even if this were not the case, these credit intercession activities are incidental to the Agencies' principal functions.

The law does not require that an organization must perform its exempt functions solely for the benefit of low-income individuals to qualify under IRC 501(c)(3). Organizations may be properly designated under IRC 501(c)(3) notwithstanding the fact that the general public is served.

Nonetheless, the Agencies do not charge a fee for the programs that constitute their principal activities. A fee may be charged for a service that is an incidental part of an agency's function, but even where a fee is so charged it is nominal. Moreover, even this nominal fee is waived where payment would work a financial hardship.

Exemption Applications Case Development

A Critical Eye

The public, the federal government, and the states give great weight to the Service's determination of exemption. Thus, it is essential to review applications for exemption (Form 1023/1024) with a critical eye. Because credit repair activities may be illegal, a careful review of applications from credit counseling organizations and credit repair or debt management organizations is necessary. Any case in which there is a concern that the organization, or any organizations in which its founders, officers or directors have an interest, may be engaged in non-exempt activities should be coordinated with T:EO:RA.

Sample Questions

The following questions may be used to develop cases.

1. List the names of the members of your board of directors and provide a resume for each. How much will you compensate each member for their services as a director or consultant? For each member receiving compensation, indicate how many hours/week he/she provides services to you. Provide the same information for each of your officers.

2. Please indicate whether any of your officers and/or directors are related to each other and explain the relationship.

3. Explain the expertise of each board member and officer in the area of consumer credit counseling as well as any expertise or previous experience in the credit repair industry.

4. Disclose any ownership interests the members of your board of directors and your officers (and members of their families) have in for-profit or non-profit businesses that perform credit counseling, credit repair, or provide services that will be used by you in your provision of services to the public.

5. Describe the facility that you will use to provide your services. How much rent do you pay? Is there any business or professional relationship between you and your landlord? If there is, please explain in detail.

6. Please describe the duties of each person you will employ. Provide a brief explanation of the education and experience you will require for each employee along with the salary you intend to pay. In addition, please describe any bonus structure your employees will be eligible for.

7. State whether your counselors are certified to perform credit repair services. Please indicate the name of the certifying organization and whether it is a federal, state or private certification organization.

8. Explain your advertising practices. Submit copies of all types of advertising copy that you plan to use, including TV ads, Internet ads and ads in the print media. Please submit a balance sheet detailing the revenues and expenses attributable to your advertising budget.

9. Explain in detail how you will make the availability of your services known to potential clients.

10. Explain in detail how your services will be provided. Please walk us through a client encounter from the first phone call through the expected services you will provide. In this regard, please submit:

• copies of all promotional material given to the consumer

• a copy of your customer contract

• a copy of a typical debt management plan. Please include an assessment, a comprehensive financial plan, and a written action plan.

• copies of the report you provide consumers detailing the allocation of any up-front fees

• copies of periodic reports showing the allocation of all amounts paid in

11. Please submit copies of the training material you provide your counselors, including any recommended scripts for use with customers.

12. What do you anticipate will be the average length of time it will take a debtor to get out of debt using your services? What is your policy in the event a debtor misses one or more payments to you?

13. Explain your fee structure in detail. Please include a discussion of any voluntary contributions that are not considered fees for services. If you charge for educational material, please submit your fee schedule and a copy of all material.

14. Submit copies of all material you provide the customer explaining the fees to be charged for your services.

15. Have any of the members of your board of directors been an officer, director, or employee of a credit counseling, credit repair agency or organization issuing credit cards? If so, please explain in detail.

16. Have you obtained the licenses to do business that are required by your state or locality? Please submit a copy of each license.

17. How often are your operating and trust accounts audited? How was the auditor selected? Please submit a copy of your last audit report.

18. Are your personnel licensed, bonded, and insured? Please explain.

19. Are your services provided in conjunction with any other entities, such as credit counseling agencies, credit repair organizations or organizations issuing credit cards? Do you refer your clients to specific credit card companies to obtain additional credit?

20. Do you refer your clients to any other entities for services that are necessary for them to complete the program you set up to assist them in paying off their debts? If so, please identify the entities that you work with or refer clients to. How were these organizations selected? Please submit copies of all contracts you have with these entities.