IRS' oversight of credit counseling fails
Exempt Organizations office tries 8+ years to strip group's nonprofit status
By Fred O. Williams
Eight years after determining that a major credit counseling agency was only masquerading as a nonprofit organization, the Internal Revenue Service is still struggling to strip the agency's nonprofit status.
The IRS Exempt Organizations division -- the same office that is under fire for giving special
scrutiny to conservative Tea Party groups -- determined that North Carolina-based Consumer Education Services Inc. was ineligible for tax-exempt status in 2005. Investigators found that CESI's
strings were being pulled by a for-profit company called Amerix, which used it
to rake in fees from people trying to escape debt.
"Their (IRS) role isn't to protect the public," said
Elizabeth Maresca, a law professor at Fordham University who specializes in tax issues. "What we think is slow, they don't think is slow."
CESI, which does business as
"cesi Debt Solutions," launched an action in U.S. Tax Court in March, marking
another delay in the appeal process and making the dispute public for the first time.
The slow-motion crackdown highlights the weakness of the IRS's
oversight of credit counseling, where millions of consumers go for help to escape
credit card debt. While the IRS deliberated, CESI, the fifth-largest credit counseling agency, continued to contract with Amerix and a related company
until 2011, paying the for-profit companies up to 99 percent of its revenue.
CESI has enrolled about 140,000 people in debt management
plans since its inception, and it absorbed another 80,000 plans from two other
Amerix affiliates that it acquired in 2001 and 2003, according to tax court
The CESI story
Consumer Education Services Inc. was founded in 1998 and
received tax-exempt nonprofit status from the IRS in 1999. The agency's launch
was helped by a $300,000 loan from Amerix, which was forgiven in 2000,
according to Venable LLP attorney Jeffrey Tenenbaum, who represents CESI. The
counseling organization contracted with Amerix, based in Maryland, to keep
track of debtors' monthly payments and negotiate repayment plans with their creditors.
In 2004, Congress held hearings on credit counseling abuses
and released a scathing report that listed Amerix and CESI, among others. Amerix
controlled CESI and other nonprofits via service agreements that required them to
sell debt management plans to 30 percent of callers. Although nonprofits are
supposed to offer the plans to the needy for free, Amerix required that the plans
generate fees of at least $30 a month. Amerix received 50 percent to 85 percent
of the fees, depending on how much it was involved in recruiting the client
into a debt management plan.
These for-profit practices created pressure to sell plans to
consumers whether they needed them or not, the report said. Some people who
thought they were calling a nonprofit were enrolled in a plan by Amerix,
Bernaldo Dancel, owner of Amerix parent company Ascend One,
testified that the report's criticism prompted changes. Amerix dropped its 30
percent enrollment requirement and $30 minimum fee, he told the Senate
Permanent Subcommittee on Investigations. It also stopped enrolling people
directly in debt management plans, he said, effectively capping its revenue
from the plans at 67 percent.
But instead of diminishing, CESI's payments to Dancel's for-profit
companies increased. While its payments to Amerix fell, CESI started paying a
sister company called 3C Inc. for marketing services. As a result, the share of
CESI's revenue going to AscendOne's for-profit units climbed from 67 percent in
fiscal 2005 to 99 percent in 2006 and 93 percent in 2007, CESI's annual disclosures on Form 990 show. CESI also absorbed the debt management plans of two
other nonprofit credit counselors that also had ties with Amerix.
In harm's way
By 2010, while the IRS continued to deliberate, state
regulators took action against the for-profit contractors linked
"AscendOne used nonprofit credit counseling agencies as
a front to take advantage of consumers," then-Washington Attorney General
Rob McKenna said in a statement announcing a 2010 settlement with 20 states. Debtors
thinking they would get advice from a nonprofit instead received little or no
counseling, but were sold debt management services from for-profit companies that
did not necessarily help their finances, the states charged. AscendOne admitted
no wrongdoing but agreed to pay a $4.5 million fine.
Complaints from CESI clients show that signing up for a debt
repayment deal can have expensive consequences. In 2012 "Mrs. R."
told the Better Business Bureau that CESI increased the automatic payments it
deducted from her bank. After paying into the plan for 27 months, including a
monthly fee to CESI of $47, she filed bankruptcy.
"Although they knew I was in hardship and the payment
was too high, they continued to remove funds from my account without providing
any other options available to me, like bankruptcy," said the woman, whose
name was kept private by the BBB. CESI responded to the BBB that the payment
plan was voluntary, including the increase in monthly payments, and refused to
refund the more than $1,000 in fees it collected from "Mrs. R." CESI
has an A+ rating based on its record of resolving consumer complaints, BBB records
The share of CESI's total revenue paid to for-profit contractors Amerix Corp. and 3C Inc. for fiscal years 2003-2011.
CESI cuts ties; Amerix
CESI decided to break its ties with Amerix after the IRS said
in 2011 that it must do so to keep its nonprofit status, Tenenbaum said. As a
result, CESI let the servicing agreement expire, and Amerix and 3C Inc. sued it
for termination fees in North Carolina. Under a 2012 settlement, CESI pays
Amerix a declining stream of payments from debt management plans that were in
place during the last contract. There were about 58,000 people enrolled in CESI
debt management plans, Amerix's October, 2011 court filing said. Payments to
Amerix and 3C Inc. fell to 46 percent of revenue in fiscal 2011, marking the
first time since its founding that payments to Dancel's companies consumed less
than 50 percent of CESI's total revenue.
The service agreement filed with the court showed CESI's extensive
financial obligations to Amerix. CESI was required to pay Amerix 50 percent to
68 percent of fees from consumers' debt management plans, plus a $1 million
charge for the right to participate in business initiatives such as customer
feedback surveys and website redesign.
Amerix also had a claim on "fair share payments"
from creditors and required CESI to reimburse it for phone usage, taxes and
regulatory fees connected to the services provided by Amerix. CESI gave
Amerix a security interest in consumers' debt management plans too.
The long road
Why does it take so long to yank an organization's nonprofit
The IRS is not saying. Not only are its deliberations
lengthy, they are also secret, compounding the risks to debtors seeking help. Representatives
of the agency did not respond to repeated requests for comment about the CESI
case or its procedures in general. According to tax court filings by CESI, the
IRS told it in 2010, after a nearly three-year gap in communication, that the case
had been "misdirected" within the agency.
The policy for protecting taxpayers means there is no
provision to warn the public, even when IRS auditors have concluded that an organization
is not a legitimate nonprofit.
"It hamstrings the IRS a bit in terms of
communication," said Philip Hackney, assistant law professor at Louisiana
State University and a former lawyer at the IRS Chief Counsel's office.
Hackney, who worked on tax exempt organization issues as an
IRS attorney, said it is not unheard of for the agency to take a decade to cancel
an organization's nonprofit's status when appeals are involved.
In the IRS Exempt Organizations report for fiscal 2012,
Director Lois Lerner discussed a "mismatch" between expectations
about how long projects would take, and how long they actually took. "Many
of EO's projects are complex and require sophisticated planning and
execution," she wrote, "so they rarely fit conveniently into a fiscal
or calendar year and may go through several phases over their lifetimes."
In May, Lerner invoked her Fifth Amendment right not to
incriminate herself and refused to testify before a Congressional committee
investigating the IRS' targeting of conservative groups for special attention.
She was placed on administrative leave.
Nonprofit status from the IRS brings a host of benefits. Without
it, CESI says it would likely go out of business. Nonprofits are exempt from
the Credit Repair Organizations Act, freeing them from requirements that for-profit debt
settlement companies must meet, and shielding them from regulation by the
Federal Trade Commission, which oversees other debt solution companies.
"Congress ends up using that (nonprofit) status for all
sorts of other things," Hackney said, making the IRS a proxy for consumer
protection regulators. "The IRS is very aware of it ... it's not set up to
be handling those issues."
Another major advantage comes from creditors, which negotiate
write-downs of consumers' debts with nonprofit credit counselors, an advantage
that for-profit debt relief companies lack. And consumers frequently seek out
nonprofits, thinking that charitable organizations will provide unbiased help
at lower cost than others.
A crackdown delayed
CESI isn't the only example of a long-delayed crackdown. Earlier
this year another credit counselor, Take Charge America, settled with the IRS to keep its nonprofit status, ending a revocation process that
began in 2005. The IRS found that the organization was being run for the
benefit of its founder, Michael Hall, whose for-profit software company
collected payments from the nonprofit organization he headed, and whose family
members received salaries for numerous executive-level jobs. By the time of the
settlement in 2011, Hall and most of his family had left the organization, and
a new board of directors bought out contracts with his software company.
The Take Charge America settlement could set a template for
the eventual resolution of the CESI dispute. One possible outcome of the tax
court action is a settlement, Tenenbaum said.
The end of the disputed moves could cap a long-running IRS
project, the Credit Counseling Compliance Project. According to updates on the project
issued in 2006, the IRS had examined 63 organizations and revoked tax-exempt
status of nine of them.
"[T]he IRS has found that many credit counseling
organizations operating as tax-exempt charities are now primarily sellers of
debt-reduction plans, motivated by profit, and offering little or no counseling
or education," the report said. "In many cases, the credit counseling
organization also serves the private interests of related for-profit
businesses, officers and directors."
See related: Behind the curtain: The business of credit counseling
Published: June 4, 2013