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Sunday, December 10, 2006


Generally, organizations conducting "educational" activities can qualify as exempt from income tax under Code Section 501(c)(3). A number of organizations exist to educate consumers on how to deal with consumer credit. These consumers often have existing creditor problems, and the organizations educate them on how to work through their credit problems and how to better manage their finances to avoid future problems. Often these organizations also take a direct role with the consumers in working out existing creditor problems, including budgeting, individual counseling, and escrow and payment arrangements to help satisfy existing creditors. Such activities are not "educational," but when directed towards low-income individuals and families, they qualify as exempt as "charitable" by reason of relieving the poor and distressed.
There are a number of cases and rulings that confirm the availability of exempt organization treatment for such organizations. As is often the case with exempt organizations, the availability of exempt organization treatment attracts some taxpayers that will try to characterize what is really a "for-profit" venture into one that has enough exempt characteristics to obtain an exemption ruling. With the ruling, the organization avoids federal income taxes on its exempt activities, and contributors are eligible for a tax deduction for their contributions.
A recent private letter ruling illustrates such a failed attempt. It is instructive to note some of the facts that the IRS relied upon in denying Section 501(c)(3) status to the applicant:
-over 40% of activities were related to debt consolidation and management activities, for which the consumer being helped is charged a fee;
-there was significant advertising expenses for the sale of such debt management services;
-services are not limited to lower income persons, but are "sold" to the general public;
-while the organization claimed it would provide courses and seminars focusing on money management and budgeting, it failed to substantiate an educational methodology. Further, it did not provide specific information about its seminars (i.e. agenda, literature describing the seminars, and dates and times of the seminars), as well as how it would integrate these seminars into its operations. It also failed to budget funds for educational materials, workshops, or other educational, thus creating doubt whether it would really undertake such activities;
-creditors may make fair-share "contributions" to the organization, in reality because they benefit from the activities of the organization since it effectively helps them get paid on their consumer loans and credit (that is, the counseling organization acts as a debt collection agency);
-no evidence was presented that the organization received contributions from disinterested members of the public;
-there is a risk that private individuals will inure benefits from the organization, due to (a) high compensation paid to officers, and (b) a related entity for back office debt processing and software services.
There are a number of these organizations out there. With the ruling, the Services is reminding taxpayers that unless such organizations restrict their activities to education, and/or providing services at free or low-cost to low-income taxpayers, and do not seek to find methods of providing economic benefits to founders or related parties, obtaining exempt status for these types of consumer credit counseling services will be difficult.
Private Letter Ruling 200649035. See also Private Letter Ruling 200649033.

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