Just weeks after federal investigators lowered the boom on home financing assistance firms using illegal tax-exempt status, the Internal Revenue Service is outing credit counseling and other agencies for similar infractions.
After a two-year audit of 63 credit counseling agencies, representing 56 percent of the industry's revenues, audits of 41 agencies, representing 40 percent of the industry's revenues, have resulted in revocation, proposed revocation or other termination of their Internal Revenue Section 501(c)(3) tax-exempt status.
The status was initially granted because the agencies promised to provide educational and counseling services to financially strapped consumers trying to get out of debt. Too often, little or no counseling or education was actually offered. Instead, profit was the primary motivator, the IRS reports.
In a tragic twist, many who turn to credit counseling agencies to dig out of debt were buried by predatory lending tactics or related schemes in an oppressive mortgage financing climate the Federal Bureau of Investigations has called a "growing epidemic of mortgage fraud".
The FBI said mortgage fraud is an outgrowth of a housing boom that has attracted record numbers of legitimate buyers and investors, as well as growing numbers of "industry insiders" who use collaboration and collusion to cash in on the market.
In a related action, the IRS also names organizations, which since February 2005, have been determined to no longer qualify to receive tax-deductible contributions under Internal Revenue Section 170(c)(2). Credit counseling agencies are included on the list.
It's just the tip of the iceberg.
The federal agency is pulling compliance checks on each of some 743 credit counseling agencies, virtually all such agencies with or seeking tax-exempt status. After evaluating 110 applications, only three have been approved for tax-exempt status, 95 were not approved and 12 are pending.
"Many offered little or no counseling or education and appeared to be primarily motivated by profit. In many instances, these agencies also served the private interests of related for-profit businesses, officers and directors," the federal tax agency reported.
The IRS says legitimate credit counseling organizations provide valuable services to those in need, but too many of them have used their tax-exempt status to circumvent consumer protection laws and take advantage of those who are already in financial distress.
In the past 10 years, consumer protection laws have inadvertently helped boost the non-profit credit counseling cottage industry, and with it the incidence of fraud.
The Credit Repair Organization Act, first effective in 1997, was designed to better regulate the for-profit credit repair business, but exempted Section 501(c)(3) organizations from its provisions. State laws mirrored federal provisions.
However, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), which mandates that bankrupt consumers get credit counseling and education, forced closer scrutiny of credit counseling firms, which must be certified by the U.S. Bankruptcy Court to provide bankruptcy counseling and financial education.
"Over a period of years, tax-exempt credit counseling became a big business dominated by bad actors," said IRS Commissioner Mark W. Everson in a prepared statement.
"Our examinations substantiated that these organizations have not been operating for the public good and don't deserve tax-exempt status. They have poisoned an entire sector of the charitable community," Everson added, echoing similar comments issued weeks ago when the IRS released findings on illegal tax-exempt home financing assistance schemes.
Then, looking into operations that used seller-funding to finance buyers' down payments and closing costs in a "self-serving, circular-financing arrangements," the federal investigators said not only is such a tax-exempt scheme illegal, the operations artificially inflate the cost of housing, undermine mortgage underwriting quality and put home ownership at risk.
"They also damage the image of honest, legitimate charities," Everson said about the down payment operations.
The down payment assistance and credit counseling industry actions are part of the Bush Administration's larger crackdown on tax cheats and fraud in the non-profit and charity sector of the economy.
In a "Consumer Alert On Credit Counseling Organizations" earlier this year, the IRS included credit counseling agencies among the " 'Dirty Dozen' Tax Scams for 2006", an annual tally of what the agency considers the most notorious tax scams.
In the spring of 2003, "Credit Counseling In Crisis: The Impact on Consumers of Funding Cuts, Higher Fees and Aggressive New Market Entrants," found that too often credit counseling agencies offered improper advice, deceptive practices, excessive fees and abuse of their non-profit status.
The work of the National Consumer Law Center (NCLC) and the Consumer Federation of America (CFA) was the first ever such study of credit counseling agencies.
