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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."

IRS oversight of credit counseling fails

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 papers.

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, without counseling.

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 to CESI.

"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 say.

Not for profit? Not really.

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 sues
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 rights?

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 seekers
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


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