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For those who work in and around the credit counseling industry these days, the million dollar question seems to be: What are the characteristics that a nonprofit consumer credit counseling agency ("CCA") must have (and not have) in order to be recognized as tax-exempt, or to maintain its tax-exempt status, under Section 501(c)(3) of the Internal Revenue Code (the "Code"). At present, there is a limited amount of published guidance from the Internal Revenue Service ("IRS") and case law specifically addressing federal tax exemption for CCAs. However, while there is a dearth of precedential guidance, there is no shortage of enforcement activity in the industry these days - all of which is very instructive in answering "the question." In addition, IRS representatives have spoken over the last couple of years at a number of industry conferences and have met on multiple occasions with industry representatives, all shedding additional light on this matter.

So while the IRS has yet to issue a single, comprehensive, practical guide to tax exemption for CCAs, all of the above, when taken together and distilled, can provide some valuable answers to the tax-related questions the industry has been asking. This article is designed to do just that. The article begins by briefly summarizing the legal history and context of CCA tax exemption, followed by a brief discussion of the three principal legal problem areas the IRS has been focusing on in its audits of tax-exempt CCAs and its denials of CCA applications for recognition of tax-exempt status. It then proceeds to lay out, in a comprehensive fashion, the key positive and negative factual factors bearing on a CCA's qualification for tax exemption under Code Section 501(c)(3).

Legal Context

In the past, CCAs had been successful in being recognized by the IRS as exempt under Code Section 501(c)(3) by virtue of a determination by the IRS that such organizations are engaging in sufficient public education activities.  Thus, tax-exempt CCAs are not structured as charitable Code Section 501(c)(3) organizations, but rather as educational Code Section 501(c)(3) organizations. As such, a CCA's ability to continue to maintain such Code Section 501(c)(3) status will depend largely on its ability to demonstrate that its activities result in the provision of substantial public education.

Under Section 1.501(c)(3)-1(a)(1) of the Income Tax Regulations (the "Regulations"), Code Section 501(c)(3) organizations must be both organized and operated exclusively for one or more purposes as specified in the Code, such as for educational purposes. An entity is operated for exempt purposes under the Regulations if it engages primarily in activities that accomplish its exempt purpose under Code Section 501(c)(3). The Regulations also state that an entity is organized exclusively for exempt purposes if its governing documents (articles of incorporation and bylaws) limit its purposes to one or more purposes listed as exempt in Code Section 501(c)(3).

In the late 1970s, federal courts in two separate instances reversed the IRS' revocation of tax-exempt status for CCAs (Consumer Credit Counseling Service of Alabama v. United States1 and Credit Counseling Centers of Oklahoma, Inc. v. United States2).  Both courts held that the CCAs at issue furthered their exempt purposes because they provided information on the use of credit which was useful to the individual and beneficial to the community. The courts in these cases considered a number of factors: these organizations held classes and seminars; the boards were representative of the general public; the debt management program ("DMP") services that were provided were a minor, insubstantial activity of the organizations; and the fees charged for the DMP were nominal and were waived in hardship cases. 3

Subsequent to those decisions, there had been little court or IRS action until very recently, when high-profile media coverage and congressional hearings focused on perceived abuses among some of the larger CCAs. The IRS’ current focus on tax-exempt CCAs stems, in large part, from such scrutiny. The IRS recently issued a Chief Counsel Advice Memorandum (the "IRS Memorandum")4 regarding tax exemption for CCAs, which focused on two 1960s Revenue Rulings5and the two 1970s federal court cases discussed above.  On the enforcement side, the IRS has embarked on an aggressive enforcement campaign, conducting more than 50 audits of tax-exempt CCAs (and reportedly issuing at least a half dozen initial revocation letters to date) and issuing a number of detailed denial letters to organizations that have recently applied to the IRS seeking recognition of tax-exempt status under Code Section 501(c)(3).6 To date, however, the only IRS guidance thus far issued has been a continuing professional education article for IRS agents 7 and the IRS Memorandum. 

It should be noted that while dozens of audits of CCAs have begun, we are aware of no such IRS audit that has yet fully concluded. We have learned informally in conversations with senior IRS officials that the agency will aggressively seek to revoke the tax-exempt status of CCAs that exhibit significant problems and that, to date, most of the IRS' audits have revealed such significant problems. Of course, CCAs that have had their tax-exempt status revoked often should have the option of instituting changes in their organization and operations that are acceptable to the IRS and then re-applying for recognition of their tax-exempt status (on a prospective basis). IRS officials have informed us that, in certain cases where warranted, they will assist such organizations in expediting IRS review and approval of their (prospective) exempt status applications (although we are not aware of any case in which this has yet occurred).

1.  Substantiality of Education Versus Substantiality of Non-Exempt Purposes.  As of late, the IRS has questioned whether the provision of telephone "counseling" to consumers constitutes sufficient public education for purposes of Code Section 501(c)(3) tax exemption.  Specifically, the IRS has expressed concern that, in many cases, CCAs' scripts, advertisements and the like demonstrate that a substantial purpose of such agencies is the enrollment of individuals into debt management plans.  The IRS takes the position that, in general, DMP activity is not substantially related to or in furtherance of a CCA’s tax-exempt purposes and, if substantial, is sufficient to risk the CCA's tax-exempt status. Further, a significant factor relied on by the IRS in determining whether an organization is operating for a substantial non-exempt purpose is to determine whether the organization is operating similar to the manner in which a for-profit enterprise operates. Thus, the IRS has cited the routine purchasing of leads, the use of traditional for-profit telemarketing practices, the use of aggressive advertising promoting debt management plans, the lack of the provision of widespread community education, the lack of independent, volunteer board oversight, control by for-profit entities over CCAs, the lack of independent sources of income (i.e., other than from debt management fees and "fair share" payments), prices that are at or above the amount necessary to pay for the services provided, and similar practices as evidence of the existence of a substantial non-exempt purpose (see, generally, IRS Memorandum). While many CCAs take the position that the time spent on the telephone with clients and potential clients should be considered time spent providing education to such individuals, the IRS appears reluctant to accept such an argument when an organization’s counseling scripts or guidelines – and actual practices – demonstrate otherwise.  Thus, an organization that devotes the majority of its resources (i.e., time and/or money) to DMP-related activities is at risk of having its tax-exempt status revoked by the IRS under the theory that such activity is not educational but rather is an activity in furtherance of a non-exempt purpose.

 2.  Private Benefit.  Many tax-exempt CCAs have close relationships with for-profit service providers that result in a significant amount of money being paid by a tax-exempt organization to a for-profit entity or individuals (either directly by the tax-exempt organization or indirectly by its clients), or a significant benefit otherwise flowing to the for-profit entity or individuals. In many such circumstances, the IRS has taken the position that such a relationship results in a significant amount of prohibited "private benefit" and thus the tax-exempt organization’s exempt status should be revoked. The private benefit analysis is a balancing test, with the benefit to private individuals or entities on one end of the scale and public benefit on the other end; if the private benefit is more than merely incidental to, and is not notably less than, the public benefit resulting from the CCA's operations, Code Section 501(c)(3) tax exemption may be jeopardized. In addition to the relationships with for-profit service providers, the IRS also is scrutinizing closely the manner in which credit card issuers benefit as a result of CCAs’ debt management activities. According to the IRS Memorandum:  "...the way in which credit counseling organizations and their trade associations have recently been tailoring their operations and standards to attend directly to concerns of credit card companies may also provide evidence to support a substantial non-exempt purpose and/or private benefit argument for revocation of exemption."

3.  Private Inurement.  Similar to the private benefit prohibition, Code Section 501(c)(3) prohibits an exempt organization from operating in a manner that results in an unfair benefit being paid to a private individual or entity from the exempt organization. However, unlike the private benefit prohibition, this prohibition on "private inurement" applies only when the benefit received from the tax-exempt organization is one that is greater than the fair market value of the services provided by the individual or entity to the organization. Moreover, the prohibition applies only when the individual or entity benefiting is an "insider" with certain close connections with and/or control over the organization. Private inurement risks often arise when one or more employees, officers or directors of a tax-exempt organization – or for-profit companies owned or controlled by such individuals – are paid large salaries or receive other compensation or benefits that are not commensurate with the fair market value of the services such individuals provide to the organization. (Note that Code Section 4958 authorizes the IRS to impose substantial tax penalties on "insiders" who benefit unfairly from a Code Section 501(c)(3) organization and on Code Section 501(c)(3) organization "managers" who approve such transactions; these penalties are commonly referred to as "intermediate sanctions.")

Positive and Negative Factors Bearing on a CCA’s Tax-Exempt Status

The summary below outlines positive and negative factors, relating to several significant legal and factual issues, that we believe the IRS would consider when evaluating a CCA for recognition or maintenance of tax-exempt status. Many of these factors are subjective in nature; in certain cases, a CCA's specific facts and circumstances may fall on a continuum somewhere between the positive and negative factors described below. In addition, the factors should not be viewed as an all-inclusive list; there may well be other material factors that are not listed here. In addition, as this is what the IRS views as a "facts and circumstances" analysis, it is certainly possible that some CCAs may satisfy many, but not all, of the positive factors listed below and still qualify for recognition of their tax-exempt status. Conversely, none of the negative factors are, in and of themselves, determinative; the presence of one or more negative factors does not necessarily result in disqualification for tax exemption. In short, the analysis contains no bright-line tests, making its application very challenging for the CCA community.

1. Debt management plan enrollment versus educational counseling.

Positive Factors

  • Credit counselors educate and counsel consumers first and foremost, and offer a DMP only if appropriate.
  • Counseling and education are highly interactive and customized to the needs and circumstances of individual consumers.
  • Counselors spend a significant amount of time counseling consumers over the telephone; the more time spent with each consumer offering counseling and education, the more likely the IRS will find that the CCA's primary purpose is education rather than a non-exempt purpose. 
  • CCA managers monitor counselors' telephone calls with consumers to ensure that the requisite amount and type of education and counseling are provided on each call, and that the focus is not on DMP sales.
  • The CCA publishes and distributes an employee training manual or other written guidelines instructing counselors that their primary purpose is to educate consumers – not to sell DMPs.
  • The CCA commits substantial human and financial resources toward educational efforts; a significant percentage of total employee hours should be dedicated to education rather than to DMP enrollment and administration.
  • The CCA closely links its educational function to the DMP process.  For example, (i) every customer service telephone call from a DMP client to a CCA should be treated as an opportunity to counsel that client; the customer service function should be handled by employees of the CCA qualified to provide such counseling and should not be outsourced, and (ii) require consumers to read new educational content prior to being permitted to make their monthly payment to the CCA (or develop comparable alternatives to more closely tie DMPs to the CCA's educational purpose).
  • The CCA mails or e-mails educational materials to consumers on a regular/monthly basis when mailing consumer DMP statements and monitor/evaluate the extent to which such materials are being read and understood.
  • Counselors are compensated on a straight salary or hourly-rate basis; no commissions or other forms of compensation based on the number of DMPs enrolled or on any similar basis are paid to counselors.
  • Only counselors who are well qualified to offer consumer financial education and counseling are employed; meaningful counselor certification is important, but is not determinative of qualification to provide counseling.
  • Counselors and education providers are all employees of the CCA.
  • Counselors regularly and routinely contact a consumer after the consumer enters a DMP to support the consumer and offer additional counseling and educational assistance not related to DMP administration.
  • The CCA's articles of incorporation and bylaws clearly reflect the CCA's educational purposes and otherwise conform to all IRS requirements for Code Section 501(c)(3) organizations.

Negative Factors

  • Counselors ask consumers questions solely for the purpose of qualifying the consumer for a DMP and offer educational assistance only after an individual has "qualified."
  • Counselor script, guidelines or employee training manual effectively instructs counselors to screen consumers for DMP eligibility.
  • Telephone conversations with consumers are cut short when it is clear they will not qualify for a DMP plan.
  • Counselors offer only brief, scripted, superficial "counseling."
  • The CCA sets goals for counselors to speak with a certain number of consumers each hour and/or, in fact, counselors speak with a relatively large number of consumers each hour.
  • The CCA sets DMP quotas or goals for counselors.
  • Educational materials are offered only to those consumers who enroll in a DMP but not to others who contact the CCA, or more significant educational materials are offered only to DMP clients.
  • Counselor compensation, whether salary, bonus/commission, or both, is based (in whole or in part) on the number of consumers enrolled in DMPs (or similar basis).
  • The CCA hires counselors without adequate training and experience in personal finance, credit and debt management.
  • Some or all of the CCA's counseling and/or educational function is outsourced to non-employees.
  • The CCA fails to offer meaningful education and counseling to DMP clients after they have enrolled in a DMP.
  • Once consumers enter DMPs, counselors fail to routinely proactively follow-up with consumers via telephone to provide counseling and educational assistance unrelated to DMP administration.
  • The CCA's articles of incorporation and bylaws do not clearly reflect the CCA's educational purposes or do not otherwise conform to all IRS requirements for Code Section 501(c)(3) organizations.

2. Other educational offerings.

Positive Factors
  • The CCA provides free education to the public through interactive delivery methods (e.g., in-person seminars, interactive Web-based programs, etc.) on personal finance topics useful to consumers – and not focused on DMP enrollment.
  • The CCA routinely offers to mail hard copies of educational materials located on the CCA's Web site to consumers who do not have access to the Internet.
  • The CCA produces its own "in-house" educational materials, including but not limited to educational articles and newsletters; employing one or more staff members devoted to this task is recommended.
  • A high percentage of overall expenditures, and a high percentage of overall staff time, are dedicated to education.
  • The CCA tracks and documents the frequency with which educational materials are sent to, and utilized by, consumers.

Negative Factors
  • Only passive, and not interactive, educational materials (such as informational articles on the CCA's Web site and links to other Web sites offering educational materials) are offered.
  • The CCA provides only or principally pre-packaged educational materials developed by third parties.
  • A low percentage of overall expenditures is devoted to educational efforts and/or a low percentage of overall staff time is dedicated to education.
  • Documentation of educational efforts is sparse.

3. Advertising.

Positive Factors
  • Advertising emphasizes the CCA's offers of free education and counseling and does not simply promote its DMP program. 
  • The CCA's Web site provides extensive educational content and prominently offers free, interactive education and counseling to consumers, irrespective of whether or not they are DMP clients.

Negative Factors
  • Advertising solely or principally refers to lowering consumers' credit card interest rates, consolidating debts, and other benefits of a DMP.
  • The CCA purchases leads from one or more third parties (particularly if those leads are then contacted solely or principally with DMP marketing from the CCA).
  • The CCA engages in telemarketing to generate prospective DMP clients (particularly if such telemarketing is focused on promoting the benefits of a DMP).
  • The home page of the CCA’s Web site emphasizes DMPs and the benefits thereof.

4. Board of directors.

Positive Factors
  • A majority (the more, the better) of the members of the CCA's board of directors are independent representatives of the community and not compensated by the CCA.
  • A majority (the more, the better) of the members of the CCA's board of directors have a background and experience in personal finance, debt management, credit, or related topics, and/or have a background in education.
  • The CCA has a relatively large board of directors.
  • The board of directors has adopted and follows a written conflicts of interest policy.
  • The board of directors meets a minimum of four times per year and exercises meaningful, independent oversight and control over the CCA's activities.

Negative Factors
  • The CCA's board of directors consists solely or predominantly of members of a CCA’s management team or individuals closely related to them (through family, personal, business, or other ties).
  • A majority of the members of the board of directors are compensated by the CCA.
  • Most members of the board of directors do not have a background or experience in personal finance, debt management, credit, or related topics, or in education.
  • The CCA has a relatively small board of directors.
  • The board has not adopted and/or does not follow a written conflicts of interest policy.
  • The board of directors seldom meets and/or exercises no meaningful control or oversight over the activities of the CCA.

5. Fees.

Positive Factors
  • The CCA charges a low or no monthly fee for DMP services (solely for the purpose of offsetting the CCA's reasonable administrative expenses), and documents the reasons for setting the fee at a particular level.
  • The CCA charges a low or no initial fee to set up a DMP for a consumer (solely for the purpose of offsetting the CCA's reasonable administrative expenses), and documents the reasons for setting the fee at a particular level.
  • The CCA consistently waives or significantly reduces initial and monthly fees for cases with financial hardship pursuant to a written policy that clients are made aware of without having to inquire.
  • The CCA abides by state fee caps for clients residing in such states.

Negative Factors
  • The CCA charges more than a low monthly fee for DMP services.
  • The CCA charges more than a low initial fee to set up the DMP for consumers.
  • The CCA fails to waive or significantly reduce fees for consumers with financial hardship.
  • The CCA fails to publicize policy regarding waiver or significant reduction of fees for consumers with financial hardship.
  • The CCA fails to abide by state fee caps for clients residing in such states.

6. Other sources of financial support.  The IRS and the courts have stated that the lack of solicitation of contributions from the public/community and the fact that a CCA’s sole financial support comes from DMP fees and "fair share" payments are factors disfavoring Code Section 501(c)(3) tax exemption. CCAs should actively solicit grants and sources of income other than DMP fees and "fair share" payments to fund educational activities (and document all such solicitation efforts), even if they are ultimately unsuccessful in some or all such efforts. CCAs also generally should avoid referring to fees or payments from consumers as "voluntary contributions" (or at least avoid characterizing them as such for federal tax purposes).

7. Transactions with "insiders."

Positive Factors
  • There are no agreements with related for-profit corporations.  Moreover, there are no agreements with for-profit corporations that do not have other clients besides the CCA at issue. 
  • All or most back-office DMP processing and administrative services are handled "in-house," rather than contracting with a (related or unrelated) third party to perform such services.
  • If a CCA must enter into an agreement with a related corporation or individual, the CCA should first determine the fair market value of the goods and services it will receive by consulting reliable and adequate comparability data, and then pay the insider an amount equal to or less than the fair market value. 
  • Any decision to hire or contract with a related party should be made by those members of the board of directors who are independent and not in any way related to or beneficiaries of the would-be contractor.
  • The CCA retains all documentation related to any determination regarding a related party; such documentation should be contemporaneous and include the specific comparability data relied on, as well as confirmation that the determination was made solely by the disinterested, independent members of the board of directors.
  • Appropriate compensation surveys are conducted and/or consulted prior to setting CCA officer/executive compensation, and such compensation is approved solely by the disinterested, independent members of the CCA's board of directors.
  • Any agreements with related parties are not for an extended term, and are relatively easy for the CCA to terminate without penalty.
  • The CCA follows the procedures set forth in the conflicts of interest policy adopted by the CCA's board of directors.

Negative Factors
  • All or most back-office DMP processing and administrative services are performed by corporations that are owned or controlled by individuals who are employees, officers and/or directors of the CCA, or by individuals who have a family, personal, business, or other relationship with employees, officers and/or directors of the CCA.
  • There are service provider agreements with for-profit companies that have no clients other than the CCA at issue.
  • There are excessive (in excess of fair market value) payments to insiders for goods or services provided to the CCA.
  • Excessive compensation is paid by a related party to its owners/executives.
  • The CCA has service provider agreements with insiders, and/or executive compensation paid to officers or directors of the CCA, that were not approved solely by the disinterested, independent members of the CCA's board of directors (relying on sufficient comparability data).
  • Insufficient contemporaneous documentation exists to support the fair market value determination of fees or other compensation paid to insiders.
  • Agreements with related parties are for an extended term, and are difficult for the CCA to terminate without penalty.
  • There is no written conflicts of interest policy, or there is a failure to follow the written policy.

8. Transactions with unrelated private entities.

Positive Factors
  • The CCA performs all or most administrative and processing functions relating to DMPs "in-house," rather than contracting with third-party service providers.
  • If CCA functions are outsourced, such outsourcing is minimized to the extent possible, fees paid to outsourced service providers constitute a relatively small percentage of the CCA's total expenditures, the fees paid are at or below fair market value, the CCA exercises maximum control and oversight over the service provider, the service provider has no rights to the CCA's client base following termination of the service agreement, the CCA can terminate the service agreement with relatively short notice and without penalty, the service provider has clients other than the CCA at issue, and service providers are rotated (or at least new requests for proposals are issued) on a regular basis.
  • There are no arrangements with third parties to cross-sell or make referrals to third-party providers of products and services, such as debt consolidation loans, mortgage loans, down payment assistance, debit cards, buying or discount clubs, legal services, long-distance telephone service, Internet access, etc., particularly where the CCA is compensated for such referrals.
  • If referrals are made to, for instance, debt settlement companies or bankruptcy attorneys, where such referrals are in the best interests of the consumer considering the consumer’s financial circumstances, no consideration is provided to the CCA for such referrals, and consumers are referred by the CCA to more than one such company/professional (all of whom are well qualified to assist the consumer).
  • The CCA seeks grants from credit card providers that are not in any way based on the number of CCA clients paying off debts to such providers.

Negative Factors
  • A significant portion of the CCA's expenditures constitute fees paid to one or more for-profit entities for services provided to the CCA.
  • All or most CCA administrative services are performed by one or more for-profit service providers.
  • One or more staff members of the CCA are employed by a for-profit service provider.
  • Fees paid to for-profit service providers are above fair market value.
  • The CCA does not exercise maximum control and oversight over its service providers or a service provider exercises too much control over the CCA.
  • One or more outsourced service providers retains rights to the CCA's client base following termination of the service agreement.
  • It is difficult for the CCA to terminate the service agreement on relatively short notice without penalty.
  • The for-profit service provider does not have any clients other than the CCA at issue.
  • Service providers are not rotated, and/or new requests for proposals are not issued, on a regular basis.
  • The CCA contracts with one or more third parties to cross-sell or make referrals to third-party providers of products and services, with a fee paid or other consideration provided to the CCA for such referrals.
  • "Fair share" payments, grants or other revenues received from credit card providers are based on the number of CCA clients paying off debts to such providers.

9. Compliance with federal and state consumer protection laws applicable to CCAs.

Since the primary purpose of tax-exempt organizations is to benefit the public interest, CCAs must ensure that they are in compliance with all federal consumer protection laws and regulations (such as Section 5 of the Federal Trade Commission Act, the Gramm-Leach-Bliley Act, the Credit Repair Organizations Act, the CAN-SPAM Act, and the Telephone Consumer Protection Act, all generally enforced by the Federal Trade Commission ("FTC")), as well as all state laws and regulations applicable to CCAs (such as state licensing, bonding and fee cap requirements). Violations of such laws and regulations can be an indication to the IRS that the CCA is not operating for the benefit of the public or the community, as well as creating potential liability with the FTC and/or at the state level (both with state departments of financial institutions and with state attorneys general offices).


10. Document all actions.

Just being able to "say" that a CCA has adopted many or all of the recommendations set forth herein will not be enough to keep government regulators at bay. Each and every positive step taken should be documented scrupulously and retained in the CCA's records. For instance, carefully track and document the total percentage of employee time spent on non-DMP-related education and counseling. Items such as educational program agendas, attendance lists, Web site utilization data, grant applications, counselor scripts, counselor training materials, counselor personnel files, databases reflecting contact with clients, board meeting minutes, requests for proposals and proposals received for outsourced services, and the like should be retained in order to demonstrate to the IRS and other regulators the actions taken by the CCA to comply with all tax and other legal requirements.

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For more information, contact the authors at 202/344-4000, or at jstenenbaum@venable.com or geconstantine@venable.com.





178-2 U.S.T.C. 9660 (D.D.C. 1978).
279-2 U.S.T.C. 9468 (D.D.C. 1979).
3The debt management activities of the tax-exempt organizations that were the subject of the two court decisions made up approximately 12 percent of employees' time, with the remainder of the time spent offering education to the general public and free counseling on budgeting and the appropriate use of consumer credit.  Further, the revenue received in the form of credit counseling fees was "an incidental amount" compared to other sources of revenue, such as government and foundation grants. It is conceivable that the IRS would find that an organization that spends substantially more time on and reaps substantially more income from debt management activities will not qualify for tax-exempt status.
4ILM 200431023 (July 14, 2004).
5Rev. Rul. 65-299, 1965-2 C.B. 165; Rev. Rul. 69-441, 1969-2 C.B. 115.
6See, e.g., IER 20044046E (March 23, 2004); IER 20044044E (April 28, 2004); IER 20044045E (May 14, 2004); PLR 200450039 (September 14, 2004); PLR 200450037 (September 17, 2004); PLR 200452036 (September 29, 2004).
7"Credit Counseling Organizations," by Debra Cowen and Debra Kawecki, IRS CPE 2004-1.