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Credit Counseling Crackdown by the IRS

Credit Wise (featured column)
by Jennifer Wallis

You may have heard the recent news stories about the IRS revoking the 501c3 tax-exempt status of 41 credit counseling agencies. If you are a currently a credit counseling client or considering becoming one, you’re probably wondering what this means to you. If you have a relationship with a local credit counseling agency, you may have questions about how this IRS scrutiny will affect the industry. I am currently on a plane returning from the national conference of the National Foundation for Credit Counseling (NFCC). We listened to 2 guest speakers regarding the actions of the IRS so I can answer some of those lingering questions.

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First, I’ll start with a little background on the credit counseling industry. About 12 years ago, there were approximately 200 credit counseling agencies. All were members of the NFCC. These NFCC members are held to high member standards and focus on educating consumers to become better money managers. Then, the market was opened up to non-NFCC agencies. While some other non-NFCC agencies may be legitimate, many are not. The Debt Management Plan (DMP) offered by credit counseling agencies was seen as a huge money making opportunity to the “new entrants” into the industry. DMP clients agree to repay their creditors and in return, could receive lower interest rates, waived fees, and lower payments. Since DMP clients are repaying their debts instead of not paying or filing bankruptcy, many creditors pay a contribution to the credit counseling agency based on the amount that clients pay back. These “new entrants” applied for tax-exempt status under the IRS 501(c) 3 code just like the NFCC agencies and applied to become non-profit agencies. The 501(c) 3 designation requires agencies to operate for educational purpose. When the IRS was flooded with applications years ago, they did not closely scrutinize all of the agencies that were applying. They had approximately 1100 agencies apply for the 501 (c) 3 status that would allow them to operate as non-profits and educational entities.

The problem is that many of these “new entrants” did not have education as their focus. While some may have entered the market to educate consumers, far too many saw the credit counseling industry as fertile ground for making money. Cha-ching! Some major players such as the now bankrupt Ameridebt faced serious Senate scrutiny 2 years ago. The Senate investigations found that many “new entrants” were more interested in pushing clients into profitable DMPs instead of spending time educating them. Instead of counseling consumers on financial issues, they would figure out if they were DMP candidates in a few minutes on the phone. If not, they did not receive financial management education. Unscrupulous agencies paid their management huge salaries (some more than $400,000 per year) and many of these “non-profits” had business relationships with for profit agencies. Some would steer DMP clients into a more profitable loan with a for-profit partner, often owned by a relative of the CEO of the non-profit credit counseling agency. Others charged high fees to already financially strapped consumers. The Senate uncovered just how serious these problems were in the credit counseling industry and the IRS took notice.

The IRS realized that maybe they should have scrutinized those 1100 applications more closely. Since 2003, the IRS has approved only 3 applications to become a 501 © 3 credit counseling agency. They virtually stopped adding new agencies that did not have consumer education as their legitimate purpose. What could they do about the ones they had already approved? Well, that is the reason for the current IRS review.

Earlier this year, the IRS audited 63 credit counseling agencies. Just last week, they announced that they were revoking the 501 (c) 3 status of 41 of those agencies. The results of the other 22 audits are pending. It is important to note that none of the revoked agencies are NFCC members. The IRS revoked their tax-exempt status for numerous reasons ranging from not enough educational purpose to serving their own self interest.  Most other credit counseling agencies were given “compliance surveys” to ensure their educational purpose. Based on these surveys, more audits may follow. After the IRS gives the green light to some agencies based on the survey results, they plan to launch a website of approved credit counseling agencies in the coming months.

So, now that I have bored you to sleep with all of this industry jargon, wake up! Here comes the good part.

What does this mean to you? It means a few important things. 

All credit counseling agencies are not created equal: 

Just because they say they are a “non-profit” agency, it does not mean that they have your best interest in mind. If they try to pressure you into a repayment plan or attempt to steer you to a partner company for a loan, RUN in the opposite direction. A legitimate agency will never pressure you. They work for you. They should review your income, living expenses, debts, assets and liabilities and they should help you regardless of your interest in a Debt Management Plan (DMP). If they don’t teach you something during your counseling session, I’d find help from another source.

The IRS is actually being helpful: 

There is no doubt that someone needs to sweep out the abuses in the credit counseling industry. It isn’t fair for profit motivated agencies to masquerade as an education driven 501 © 3. The IRS has taken on the task of cleaning up the industry. As long as they are fair to legitimate educational agencies, this scrutiny is not only a good idea, it’s necessary.

If you are a credit counseling client, will your credit counseling agency be in trouble? It depends. If they legitimately educate consumers by reviewing a budget, income, debts, assets and liabilities, and other contributing factors, they will probably be fine. If they took time with you, asked your goals and then gave you an action plan to meet them, they are probably truly doing education.

You may want to ask a few questions when considering credit counseling. Some important questions to ask them: 

Are you accredited? Many legitimate agencies require accreditation from an outside source such as COA. Accreditation is a very thorough scrutiny of an agency’s operations to ensure quality. If an agency is accredited, it may be a good sign.

Are you a member of a national credit counseling organization? One that holds their members to high standards is the NFCC. There may be other legitimate organizations so ask what the member standards consist of.

Are you in good standing with the Better Business Bureau? Many unscrupulous players have complaints filed against them with the BBB. Check the BBB in the state where the company is located. You can do this online at www.bbb.org.

How many of the clients that you counsel go on a DMP? Most legitimate agencies have numbers ranging from 25% to 33%. This means that 67% to 75% of their clients just receive education. The agency makes little to no revenue from those clients. They help them virtually for free. If an agency has an unusually high number of DMP clients, beware of their tactics.

While much of this media attention on credit counseling may leave you wondering if there are any good agencies left, let me assure you that there are a lot of good ones out there. A good one will educate you and will not pressure you into a repayment plan. A good one will teach you something. A true educational agency operates with a mission and purpose to help people. You can usually tell this in the way the counselors talk to you with kindness and compassion. Most true non-profit agencies do not pay their employees extremely high salaries. Those employees are working for that agency not because they are motivated by money but because they wake up every day with a desire to make a positive difference in someone’s life. Many of the legitimate counseling agencies have been around since the 1960’s. They were here before the “new entrants” came in and I believe they will be here long after they are gone.

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Copyright © 2006 by Jennifer Wallis. All rights reserved.

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