Beginning in 2004, the Internal Revenue Service ("IRS") began scrutinizing tax-exempt credit counseling agencies ("CCAs") in a manner and scope it never had previously.1 Since then, the IRS has initiated well over 100 audits of CCAs, with an announced target of 254 total audits by the end of fiscal year 2008.2 In an audit, the IRS examines Form 990 returns to verify the correctness of the income or gross receipts, deductions and credits, and to determine that the organization is operating in the manner stated and for the purpose set forth in its application for recognition of tax exemption. The IRS has found that many CCAs fail to provide a level of public benefit that warrants tax exemption. The IRS' chief concern is that some CCAs provide little or no education or counseling, focusing rather on the marketing, sale and administration of debt management plans ("DMPs"). In addition, the IRS has found that many officers and directors of CCAs also serve (or have served) as officers, directors or owners of related for-profit businesses that profit from the CCA, directly or indirectly.
An IRS examination is not a final action by the IRS. To the contrary, an examination by the IRS is only one step in the examination process, which is then followed by a lengthy IRS administrative process, all designed to protect the rights of tax-exempt organizations. This process permits such organizations to maintain their tax-exempt status (and all of the rights and benefits thereof), and otherwise imposes no adverse consequences on the organization, until the process is concluded. Unless and until a tax-exempt organization accepts the notice of proposed revocation or the IRS ultimately prevails, the organizations that are under examination continue to remain recognized as tax-exempt organizations. Moreover, recent amendments by Congress to the Internal Revenue Code make clear that credit counseling and debt management plans are permissible activities for tax-exempt organizations to engage in, provided certain requirements are met.3 Nevertheless, an IRS audit can be a grueling, draining experience. The outcome of an IRS examination - which will look backwards at past activities as well as at current operations and organizational structure - can affect a CCA's tax-exempt status and also can result in the imposition of significant tax liability.4
Fortunately, the well-informed CCA can go a long way toward preparing for an IRS audit. While the advice and guidance of counsel is recommended in formulating and implementing your CCA's audit response and ongoing compliance with the Internal Revenue Code, the following (non-exhaustive) list of frequently asked questions - often in the form of Information Document Requests (commonly referred to as "IDRs") - should provide a helpful framework to prepare for an IRS examination. Coupled with existing IRS-provided guidance in this area - which is quite extensive and which is all available on the IRS website5 - these questions can help a CCA conduct a "mock" IRS audit to identify areas of weakness from a tax-exemption perspective. This collection of questions has been compiled from actual letters sent to CCAs by the IRS and those posed by field agents during actual examinations, as well as applicable law (including new Internal Revenue Code 501(q)). For convenience, the list is divided into two categories: (a) General Organizational Information, and (b) Credit Counseling-Specific Questions. Again, note that this list is by no means exhaustive; the IRS generally tailors each list of questions to the specific CCA under examination, using information obtained through filed Forms 990, websites and other publicly-available information.
A. General Organizational Information.
- A copy of the IRS exempt status determination letter.
- A copy of the Form 1023 Application for Exemption (including all attachments and related correspondence).
- A copy of the Articles of Incorporation, Charter, Bylaws, etc. and all amendments to these documents.
- A list of current and former officers, directors, and key employees (names, titles and addresses).
- Meeting minutes since inception.
- Biographical information for directors, officers and key employees, as well as whether these persons have been provided loans by the CCA and detailed information concerning their compensation, bonuses and benefits.
- A copy of all conflict of interest policies.
B. Credit Counseling-Specific Questions.
1. With regard to interactions with clients:
a. List all interactions with clients from the first encounter through the completion of the relationship with the client. For each interaction, indicate the name of each party involved in the interaction. (i.e., your telemarketer, your service provider, you, or any other party involved.)
b. List all information you collect from clients before or during the initial session with your organization.
c. Describe your presentation to clients during the initial session, including topics covered and options discussed.
d. List the criteria your employees use to determine which services are appropriate for a client.
e. State the number of times you meet with a client before recommending an approach.
f. Describe what, if any, assistance you provide with respect to secured debt.
g. State whether you provide a written budget analysis to all clients.
2. Copies of the following documents regarding interaction with clients:
a. Client contracts for counseling services.
b. Client questionnaires used during the initial session.
c. Prepared scripts used during the initial session.
d. Representative copies of written budget analyses.
e. Copies of all material provided to clients who do not wish to sign up for a counseling session or participate in a DMP.
f. Documents prepared before enrolling a client on a DMP or before recommending any other service.
g. If you provide clients with a current list of qualified assistance agencies or individuals, submit a copy of such list. State how frequently the list is updated.
3. If the CCA provides DMPs directly to clients, a copy of a typical DMP customer contract.
4. If the CCA refers its DMP clients to another entity rather than provide this service directly, a copy of the customer referral and all agreements between the CCA and the client as well as agreements between the CCA and the referred-to organization. Describe all contacts the CCA has with clients once a referral has been made.
5. State whether the CCA includes client accounts in a DMP if the creditor will not pay fair share. If so, the CCA will be asked to provide specific examples when this occurred and indicate the percentage of those accounts in its portfolio.
6. State the number of clients, as well as the percentage of clients, that have received CCA services without set-up charges or monthly fees imposed because of their inability to pay.
7. List the factors the CCA relies on in making the determination that a client is unable to pay.
8. For each year, state:
a. Number of clients who completed the DMP program.
b. Number of clients who are continuing to participate in a DMP program.
c. Number of clients who dropped out of the DMP program.
d. Number of DMP clients referred for a debt consolidation loan.
9. Identify all other entities, including all for-profit and nonprofit service providers, that the CCA works with or refer clients to, and state how these organizations are selected. Submit copies of all contracts between you and the identified entities.
10. Describe all business and personal relationships between the CCA and the landlord of each facility it uses to provide its services, and submit a copy of the lease for each of these facilities.
11. State whether the CCA requires participants in its DMP program to participate in ongoing educational programs during the course of their plan. If so, describe those programs in detail, including the manner in which they are presented and the experience level of the program presenters. Submit all written materials for these programs.
12. If the CCA's employees provide continuing counseling through telephone contacts, submit all scripts they use. If no written scripts exist, describe the content of the contacts.
13. Submit representative copies of all periodic assessments that the CCA performs during the duration of a DMP.
14. Describe, in detail, all workshops, classes, or seminars on financial planning, budgeting, credit/debt relief, or other educational programs you offer to the general public. For each program:
a. Provide a list of past and scheduled sessions, including any fees charged.
b. Provide the number in attendance at each past session.
c. Provide the syllabus and all written materials used for the session.
d. Provide a list of instructors and copies of their resumes.
e. State whether the sessions were offered in partnership with other entities. If so, specify each entity, the terms of the partnership, and any limitations on attendees.
15. Provide a print-out of each of the CCA's website's pages, or proposed website's pages.
16. Provide the following information about the CCA's employees:
a. List all categories of employees. (i.e., counselors, administrative staff, etc.)
b. Indicate the number of employees in each category.
c. Provide a written description of each category, listing all tasks and responsibilities.
d. List the employee's education, experience, and salary.
17. Describe the CCA's employee compensation system, including how it determines base compensation for credit counselors, all bonus or incentive arrangements you offer, and the circumstances under which counselors can qualify for them. If this system has changed since you began operations, please explain.
18. Describe all continuing education and training programs the CCA provides for its employees.
19. Provide all education and training materials, including training manuals, and state when the CCA began to offer the training.
20. Provide all written agreements the CCA's credit counselors and other employees must enter into during their employment, including employment contracts and agreements not to compete.
21. Submit your employee handbook, the CCA's personnel manual, and all other materials the CCA furnishes or plan to furnish to employees or prospective employees regarding terms of employment.
22. State how many of the CCA's counselors are certified to perform credit counseling or credit repair services. For each such counselor, indicate the name of the certifying organization and whether it is a federal, state or private certification organization. Submit a copy of the requirements for certification provided by each certifying organization.
23. State the average amount of time counselors spend in speaking with each client:
a. During an initial inquiry.
b. During subsequent calls.
c. After the client has enrolled in a DMP.
24. Submit a statement of income and expenses, which details the advertising budget.
25. Submit copies of the following advertising materials:
a. Flyers and letters distributed or to be distributed through mass media (including yellow pages, newspapers, magazines, etc.).
b. Current or prospective radio and television scripts.
c. Copies of advertisements for hiring employees.
26. Submit a list of all Internet sites on which the CCA advertises or plan to advertise, or that the CCA's website links to or that link to the CCA's website for advertising purposes.
27. State whether the CCA receives referrals from banks, credit-offering entities, local service agencies, or other organizations. If so, describe each referral arrangement and submit all written documentation relating to the arrangement.
28. State whether the CCA purchases or plan to purchase leads (i.e., names of prospective clients). If so:
a. Identify each lead source.
b. Describe the terms and conditions of your arrangements for the purchase of leads with each source. Attach copies of all contracts with each source.
c. State how many leads you purchase from each source per month.
d. State the cost of each lead per source and the annual cost for all leads.
29. State whether the CCA leaves automatic voice broadcast messages about your organization, or purchase such services from a service provider. If so, provide the name of each service provider; submit a copy of each contract, and the script of all automated voice messages.
30. List all funding sources for each year, breaking out fees for services (including set-up fees and monthly fees whether they are described as fees or contributions), fair share payments, fees from other programs, or the sale of material and contributions from disinterested members of the public.
31. Describe how the CCA allocates the client's first payment (i.e., amount for a set-up fee, service fee, contribution, or debt service). Submit copies of all reports you provide clients detailing the allocation of any up-front fees.
32. Describe the CCA's fundraising program and submit copies of all solicitation materials and all acknowledgement letters for the receipt of contributions. List the criteria the CCA uses to determine which contributions will receive written acknowledgements.
33. For each grant that the CCA has received or has applied for: a) State the source, the amount, and the purpose of the grant, b) Identify those grants from creditors who participate in your program, but do not pay fair share, and c) Attach copies of all grant requests/applications.
34. List the names and addresses of all sources that have provided, or promised to provide, the CCA with start-up capital, including the terms and conditions of each transaction.
35. State whether the CCA offered, now offers, or plans to offer, any additional services or products such as loans, credit repair, credit negotiation, bankruptcy counseling, or down-payment assistance. If so, please list those services.
36. If the CCA has applied for or obtained certification from the United States Trustee Program to be a nonprofit budget and credit counseling agency under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, provide a copy of the application and the EOUST ruling on the application.
37. If the CCA has ever been the subject of an investigation by any of the following entities, describe the complaint, state where and when it was initiated, and the result of the investigation (also submit copies of the complaint and documentation of its resolution):
a. State Attorney General.
b. State Office of Consumer Protection.
c. Better Business Bureau.
d. Federal Trade Commission or other local, state or federal agency.
38. If the CCA has ever been a party to a lawsuit, describe the subject of each lawsuit, state where and when it was initiated, as well as the result. Submit copies of all pleadings in each suit, settlement agreements, and other resolution documents.
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For more information, contact Jonathan L. Pompan at 202/344-4383 or jlpompan@venable.com.
To view Venable's index of articles and PowerPoint presentations on credit counseling agencies and related legal topics, see www.venable.com/ccds/publications.
This article is not intended to provide legal advice or opinion and should not be relied on as such. Legal advice can only be provided in response to specific fact situations.
1 See http://www.irs.gov/charities/article/0,,id=159049,00.html.
2 In addition, the IRS initiated an ongoing program to ensure continuous CCA compliance with the federal tax laws through education, examinations, a comprehensive determination process, and a public awareness program. See http://www.irs.treas.gov/charities/article/0,,id=156818,00.html.
3 See IRS FY 2008 EO Implementing Guidelines (available at www.irs.gov/pub/irs-tege/fy08_implementing_guidelines.pdf) (The IRS reported: "We began our Credit Counseling Initiative by examining 63 large credit counseling organizations, the combined revenues of which represent over 50% of the total revenues of the credit counseling industry. To date, we have revoked, or proposed the revocation of, 47 of these organizations, while two others have terminated. Through greater scrutiny of incoming applications, we also have significantly reduced the number of new credit counseling organizations. Our enforcement efforts influenced Congressional legislation that literally rewrote the exemption standards for all credit counseling organizations. We then turned our attention to the rest of the credit counseling industry. Through compliance checks and other research techniques, we identified 357 credit counseling organizations and sent them education letters. We selected 111 organizations for examination in FY 2007 and another 80 for examination in FY 2008.").
4 26 U.S.C. 501(q) (available at http://www.irs.gov/pub/irs-tege/credit_counseling_legislation.pdf ).
5 CCAs that lose their tax-exempt status can still operate as taxable nonprofits. Nonprofit status refers to incorporation status under state law; tax-exempt status refers to federal income tax exemption under the Internal Revenue Code (the "Code"). In certain states, Code section 501(c)(3) status and/or nonprofit status is necessary in order to comply with state debt adjusting laws that may require licensure and adherence to other state-imposed requirements; however, in only a very small handful of states (approximately three) is Code section 501(c)(3) status still required.