The Internal Revenue Service is stepping up its scrutiny of nonprofit consumer credit-counseling firms to see if they are legitimate charities and deserve tax-exempt status.
Some of the companies advertise heavily on cable television, urging people to consolidate credit card debt by calling their toll-free numbers. IRS officials said yesterday that the agency has initiated a number of audits on such firms after receiving complaints from consumers and government regulators.
"It is suspected that some of these organizations are acting in a commercial for-profit manner or as part of a tax shelter promotion," noted an IRS document setting agency priorities for this fiscal year, which started in October. A wider probe could be instigated, it added, depending on the results of initial exams.
The IRS also said it has told its field examiners to pay more attention to credit-counseling firms that apply for nonprofit status, because "there is a potential for abuse."
The IRS cited the policy when asked to respond to a new report on credit-counseling firms by two consumer groups, the Consumer Federation of America and the National Consumer Law Center.
The report faulted the IRS and state regulatory agencies for allowing "unscrupulous counseling agencies to grow and prosper" by claiming nonprofit status to take advantage of many of the estimated 9 million Americans who contact a credit-counseling agency every year.
In many states, nonprofit firms are exempt from regulations governing the credit-counseling business.
The report praised some newer firms for bringing consumer-friendly practices, such as phone counseling and electronic payments, to the industry. But it said some firms engage in deceptive practices, charge excessive fees, abuse their nonprofit status and give improper advice. The result, it found, has been a sharp rise in consumer complaints, with 1,480 complaints received by the Better Business Bureau last year, compared with 261 complaints in 1998.
"Aggressive firms masquerading as 'nonprofit organizations' are gouging consumers" by failing to disclose fees or deceptively claiming that their fees are voluntary, said Deanne Loonin, the law center's staff lawyer.
In many cases, Loonin said, these firms "perform like profit-making enterprises," by advertising aggressively, maintaining close ties to for-profit firms and paying their executives salaries that are much higher than the average in the nonprofit sector.
During the news conference releasing the report, a spokesman for Cambridge Credit Counseling Corp. stood up and loudly denounced it as a "smear" and "disservice to consumers." The report criticized Cambridge for paying its president and a director $312,000 a year.
An attorney for the company later called the report unfair because it only compared the salaries with those at similar nonprofit firms, and not with those at for-profit firms with the same revenue, assets and profits.
Others in the industry praised the report for accurately reflecting some problems. Joel Greenberg, a trustee for the Association of Independent Consumer Credit Counseling Agencies, which represents 54 firms, said "there are problems with some in our industry." The abuses described in the report "are certainly not the kind of operations AICCCA supports," he said. "We agree with regulation as long as it is not so cumbersome it becomes impossible to provide the service."
The report comes as Congress is moving to pass a law to make it harder for Americans to file for bankruptcy protection. One provision would require consumers to seek advice from a credit counselor before they can file for bankruptcy.
That measure is being sought by credit card firms in an attempt to reduce the number of personal bankruptcies, which reached a high of 1.5 million in 2002. Yesterday's report also criticized the credit card firms, which have traditionally paid fees to help support counseling firms, for reducing that financial support. It noted that creditors have contributed 15 percent of the debt they recovered from borrowers to these firms in past years. But last year, that figure dropped to about 8 percent.