The Internal Revenue Service (the “Service”) Office of Chief Counsel (“Counsel”) has issued a memorandum providing that organizations that engage in housing counseling may be subject to Section 501(q) of the Internal Revenue Code (the “Code”), and that activities related to the modification of the terms of a borrower’s mortgage generally do not violate the Section 501(q) prohibition on loan negotiation. On April 20, 2010, the Counsel publicly released a memorandum sent to the Exempt Organizations Technical and Determinations offices (the “Memorandum”) setting forth its position and legal analysis with respect to the application of Code Section 501(q) to organizations currently exempt from federal income tax, as well as those applying for recognition of tax-exempt status, under Sections 501(c)(3) or (4) that engage in, or are planning to engage in, activities that assist homeowners who are at risk of foreclosure.
While the Memorandum was issued to provide guidance in processing applications and analyzing the activities of exempt organizations under Code Sections 501(c)(3) or 501(c)(4), and cannot be cited as binding precedent, it is significant because it is the Service’s first published guidance with respect to Section 501(q). Specifically, the Memorandum provides guidance with respect to the applicability of Section 501(q) to foreclosure housing counseling services. Moreover, the Memorandum confirms the belief that the Service will be closely reviewing applications of would-be exempt organizations that engage in foreclosure assistance services.
The Pension Protection Act of 2006 (Public Law 109-280) enacted Code Section 501(q), which provides additional requirements for credit counseling organizations that otherwise would qualify as exempt under Sections 501(c)(3) or (4). Section 501(q) is generally applicable to all organizations exempt under Sections 501(c)(3) or (4) that provide credit counseling services as a significant part of their activities.
For purposes of the application of Code Section 501(q), Section 501(q)(4)(A) defines the term “credit counseling services” to mean (i) the providing of educational information to the general public on budgeting, personal finance, financial literacy, saving and spending practices, and the sound use of consumer credit, (ii) the assisting of individuals and families with financial problems by providing them with counseling, or (iii) a combination of the activities described in clauses (i) and (ii).
Pursuant to Code Section 501(q)(1)(A)(ii), tax-exempt credit counseling organizations must make “no loans to debtors (other than loans with no fees or interest)” and must “not negotiate the making of loans on behalf of debtors.”
Code Section 501(q)(2)(A)(ii) provides that the aggregate revenues that a credit counseling organization described in Section 501(c)(3) receives from creditors that are attributable to debt management plan services cannot exceed a specified percentage of total revenues. Section 501(q)(2)(b)(i) provides that, subject to a phase-in period, the applicable percent is 50 percent of the organization’s total revenues.
For purposes of Code Section 501(q), Section 501(q)(4)(B) defines the term “debt management plan services” to include services related to the repayment, consolidation, or restructuring of a consumer’s debt, and includes the negotiation with creditors of lower interest rates, the waiver or reduction of fees, and the marketing and processing of debt management plans.
In the Memorandum, Counsel’s office is asked whether Code Section 501(q) applies to organizations engaging in, or proposing to engage in, activities that assist homeowners who are at risk of foreclosure, assuming they provide financial education to the general public and/or financial counseling, and otherwise meet the requirements of Sections 501(c)(3) or (4).
Request for Guidance
The Memorandum describes the activities of organizations that provide counseling and educational assistance to individuals in danger of home foreclosure. According to the Memorandum, these organizations assist homeowners at risk of foreclosure by:
(1) educating such homeowners on financial topics by conducting seminars, public discussion groups, forums, panels, lectures, or workshops, or by otherwise disseminating financial educational material to these homeowners and/or (2) providing financial counseling to such homeowners.
Additionally, the Memorandum notes that these organizations “sometimes contact, or assist borrowers in contacting, the holders or servicers of mortgages to request repayment options or to modify the terms of existing mortgages to prevent foreclosure.” The Memorandum also recognizes that these organizations “may attempt to modify the interest rate, amortize the amount in default, and/or modify the time period for paying off a mortgage.”
The Memorandum concludes that organizations that provide educational information on financial topics or provide financial counseling to homeowners who are at risk of foreclosure are providing “credit counseling services” within the meaning of Code Section 501(q)(4)(A). Furthermore, an organization that engages in such activities as a substantial purpose must, in addition to complying with the requirements of Sections 501(c)(3) or (4), comply with the additional requirements of Section 501(q).
The Memorandum also concludes that the provision of housing counseling—including attempts to modify interest rates, amortize amounts in default, and/or modify the period for paying off a mortgage—will not violate the Code Section 501(q)(1)(A)(ii) prohibition on making loans to debtors and on negotiating the making of loans on behalf of debtors. In reaching this conclusion, the Service characterizes such activities as permissible debt management plan services, not the negotiation of loans.
Notably, the Service’s conclusion that certain housing counseling negotiation services constitute “debt management plan services” could give rise to an important issue not directly addressed by the Memorandum. Specifically, revenue generated from housing counseling services may need to be treated as revenue attributable to payments from creditors subject to the Section 501(a)(2)(A)(ii) 50-percent limitation. The analysis of whether such revenue counts toward the limitation likely would consider whether payments are received directly from mortgage servicers or whether they come from third parties, as well as how the payments to the organization are characterized.
Although helpful, the Memorandum lacks discussion of a number of housing counseling-related tax issues. In addition to the question of whether revenue from housing counseling services may be subject to the 50-percent limitation (as referenced above), the Memorandum does not discuss:
- The applicability of the prohibition on "negotiating the making a loan" on organizations that help homeowners refinance their existing home loans. For example, the Home Affordable Refinance Program ("HARP"), a part of President Obama's Administration's Making Home Affordable Program, is designed to assist homeowners in refinancing their mortgages. Would an organization's provision of assistance to a homeowner related to HARP trigger the loan negotiation prohibition, as refinancings involve the making of a new loan? The author of the Memorandum confirmed that it is not the IRS' intention to treat refinancing-related counseling differently than modification-related counseling, but that the way the statute is drafted made it difficult to explain and analyze it in that manner.
- The implications for organizations that directly or indirectly offer home mortgage loans (alongside counseling services) that are recognized by the U.S. Department of Housing and Urban Development ("HUD"). According to the legislative report prepared by the Joint Committee on Taxation ("JCT"), this section of the Code was enacted with an understanding that it would not impact the ability of Section 501(c)(3) organizations to provide certain HUD-approved services.
- The applicability of Code Section 501(q) to other forms of HUD-approved housing counseling services, including pre-purchase and reverse mortgage counseling.
Lastly, the Memorandum recognizes two earlier, pre-Section 501(q) Chief Counsel Advice memoranda regarding credit counseling organizations. Chief Counsel Advice 200431023 (July 13, 2004) and Chief Counsel Advice 200620001 (May 9, 2006). These memoranda—which provided in-depth support for revoking the exempt status of credit counseling organizations on multiple grounds—played an instrumental role in the Service’s aggressive credit counseling compliance project that has resulted in a very large number of proposed revocations. The Memorandum quotes the JCT report issued on Code Section 501(q) in which the JCT wrote that “[Section] 501(q) ‘does not diminish the requirements set forth [in the two memos] but builds on and is consistent with such requirements, and the analysis therein.’” (Citation omitted). Interestingly, the contents of the two Chief Counsel Advice memoranda and the excerpted section of the JCT report do not appear to be in any way relevant to the overall analysis in the Memorandum.
A copy of the Memorandum is available on the Service's website at http://www.irs.gov/charities/article/0,,id=221530,00.html. For more information about Code Section 501(q), see our article “New Tax Law Establishes Additional Standards and Requirements for Credit Counseling Agencies,” available at http://www.venable.com/new-tax-law-establishes-additional-standards-and-requirements-for-credit-counseling-agencies-10-01-2006/. For a directory of articles and presentations on credit counseling, housing counseling, and related industry legal issues, see www.venable.com/ccds/publicaitons.
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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.