IRS Targets "Not-For-Profit" Credit Counselors

Some months ago, we wrote about nonprofit credit counseling centers and raised some questions regarding their practices. Now, in her extensive article in the New York Times, Jennifer Bayot reviews the extensive investigations of these organizations by the Internal Revenue Service, the Federal Trade Commission and state regulators, who plan to issue an unusual joint advisory that will warn consumers to be wary of the total costs when they seek help from tax-exempt credit counseling organizations. C. Steven Baker, director of the Federal Trade Commission's Midwest operations, observes "these consumer credit counseling companies are using tax-exempt status as a get-out-of-regulation-free card. That's why we are teaming up with the I.R.S. on this issue."

The concern of the I.R.S. and the Federal Trade Commission is that some companies are using the tax code to avoid regulatory scrutiny by disguising their for-profit modus operandi as a non-profit, community service organization. The credit counseling "industry" operated largely under the regulatory radar for many years. Mostly this was because the volume of clients was relatively small, until the early 1990s, and the vast majority of counseling agencies were structured like community service agencies, with non-profit status and local boards of directors made up of community leaders.

The credit counseling industry has changed dramatically in the last ten years. Rapid expansion of unsecured credit (primarily credit card debt) over the past 15 years, coupled with declining stigma associated with financial problems and bankruptcy (see preceding article) fueled tremendous growth in the demand for credit counseling and the opportunity to get creditor concessions on outstanding debts. Large, nationwide counseling companies expanded at the expense of many locally owned and operated agencies. One prominent company, AmeriDebt, advertises nationwide and has almost 100,000 clients. Cambridge Credit Counseling, one of the five largest credit counseling companies in the U.S., is growing at a rate of 4,000 clients per month. Some benefits to consumers have resulted, such as 24-hour telephone and internet service to meet household time constraints. But the sources of revenue and the validation of "non-profit" have become a concern. Credit counseling agencies have traditionally received some financial support from credit grantors as well as fees from clients. But fees from clients are rising. AmeriDebt keeps 3 percent of a client's overall debt, calling it an initial voluntary contribution. Then there is the $7 a month charge per credit account, with a monthly minimum of $20. Cambridge Credit Counseling deducts the equivalent of one month of the consumer's payment under the plan established for them, plus a maintenance fee of 10 percent of each monthly payment or $25, whichever is greater. Such fees are higher than The Consumer Federation of America believes are reasonable. Increased pressure from regulators and adverse publicity apparently drove Ameridebt to announce in mid-October that it would cease advertising for new clients and focus on servicing its existing client base.