IRS Cracks Down on Credit Counselors

The IRS is cracking down on some credit counseling agencies that have been found offering substandard advice, or charging clients relatively high fees.  Some agencies have also been found using high-pressure sales tactics, while pushing debt plans that are not always in the best interests of their clients.

Back in May 2006, the IRS recommended that 41 of the 63 credit counseling groups audited to date have their tax exempt status revoked.  The names of these counseling agencies have not yet been released by the IRS.  More worrisome is the fact these 41 groups represent 40% of what is now a $1 billion credit counseling industry.  In some cases, the IRS found these agencies were recommending debt plans that were not well suited to the client's financial condition; thereby adding to an already troubled situation.

Based on their findings, the IRS has removed the tax exempt status of these agencies, since they were operating more like for-profit businesses.  The IRS continues to investigate 22 additional credit agencies.  They have also sent compliance inquiries to all of the remaining 740 known tax-exempt credit counseling agencies not currently under investigation.

Adding to the problem are recent changes in the bankruptcy law introduced in October 2005, which now requires consumers to receive credit counseling from an agency approved by the U.S. trustee before filing for bankruptcy.

Tax Exempt Status of Credit Agencies

Credit counseling agencies were originally granted tax-exempt status because they provided both educational and counseling services to clients.  To a lesser extent, these same agencies formulated debt management plans.  The credit counselor's role is to help consumers figure out if they can realistically repay their debt, or if they should file for bankruptcy.

If the counselor felt the consumer could repay their debts, they could help the placement of that same consumer into a debt management plan; in many instances consolidating the consumer's debt.  Counselors would also provide debt negotiating services, helping clients in their interactions with lenders and creditors.

In exchange for these services, these agencies charged clients a small fee and / or received a fee from creditors, such as a percentage of debt repaid.  It is this fee from creditors that creates a potential conflict of interest, as it provides an incentive for the counselor to avoid bankruptcy, even when it might be in their client's best interests.

The IRS investigation found the marketing and compensation practices at certain agencies were causing them to act more like a for-profit organization.  For that reason their tax exempt status has been revoked.  Keep in mind that the same organization can still retain its not-for-profit status while losing its tax exemption status.

Criminal investigations in this manner are not currently underway, but have not been ruled out by the IRS.

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