IRS letter 200614031: Fee based debt management program denied charity status

Plain-English summary

An organization applied for recognition as a section 501(c)(3) charity while planning to sell debt management plans through paid memberships. The IRS accepted that its articles stated charitable purposes but found that its planned operations primarily resembled a commercial business. The organization had not provided a detailed educational program, evidence of substantial counseling or education, or complete answers to the IRS's questions. The IRS denied exemption, and the denial became final after the organization did not protest within 30 days. Donors could not deduct contributions under section 170, and the organization was required to file federal income tax returns.

Ruling snapshot

• Question: Did the proposed debt management and financial planning activities qualify the organization for section 501(c)(3) exemption?
• Outcome: Denied; the proposed adverse determination became final without a protest.
• Key authorities: IRC §§ 501(c)(3), 170; Treas. Reg. § 1.501(c)(3)-1.

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Number: 200614031
Release Date: 4/7/06
SE:T:EO:RA:T:1:PE

Date: January 12, 2006
Contact Person:
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Identification Number:
UIL: 501.00-00
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Contact Number:
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Employer Identification Number:

Form Required To Be Filed:
1120
Tax Years:
All

Dear ------------:

This is our final determination that you do not qualify for exemption from Federal income tax as an organization described in Internal Revenue Code section 501(c)(3). Recently, we sent you a letter in response to your application that proposed an adverse determination. The letter explained the facts, law and rationale, and gave you 30 days to file a protest. Since we did not receive a protest within the requisite 30 days, the proposed adverse determination is now final.

Because you do not qualify for exemption as an organization described in Code section 501(c)(3), donors may not deduct contributions to you under Code section 170. You must file Federal income tax returns on the form and for the years listed above within 30 days of this letter, unless you request an extension of time to file. File the returns in accordance with their instructions, and do not send them to this office. Failure to file the returns timely may result in a penalty.

We will make this letter and our proposed adverse determination letter available for public inspection under Code section 6110, after deleting certain identifying information. Please read the enclosed Notice 437, Notice of Intention to Disclose, and review the two attached letters that show our proposed deletions. If you disagree with our proposed deletions, follow the instructions in Notice 437. If you agree with our deletions, you do not need to take any further action.
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In accordance with Code section 6104(c), we will notify the appropriate State officials of our determination by sending them a copy of this final letter and the proposed adverse letter. You should contact your State officials if you have any questions about how this determination may affect your State responsibilities and requirements.

If you have any questions about this letter, please contact the person whose name and telephone number are shown in the heading of this letter. If you have any questions about your Federal income tax status and responsibilities, please contact IRS Customer Service at 1-800-829-1040 or the IRS Customer Service number for businesses, 1-800-829-4933. The IRS Customer Service number for people with hearing impairments is 1-800-829-4059.

Sincerely,

Lois G. Lerner
Director, Exempt Organizations
Rulings & Agreements

Enclosure
Notice 437
Redacted Proposed Adverse Determination Letter
Redacted Final Adverse Determination Letter
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DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224

TA X E X E M P T A N D
GOVERNMENT ENTITIES
DIVISION

Date: November 18, 2005
Contact Person:
-----------------
Identification Number:
UIL: 501.00-00
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Contact Number:
--------------------
FAX Number:
--------------------
Employer Identification Number:

Legend:

B=

Dear -------------

We have considered your application for recognition of exemption from Federal income tax under Internal Revenue Code section 501(a). Based on the information provided, we have concluded that you do not qualify for exemption under Code section 501(c)(3). The basis for our conclusion is set forth below.

Your restated Articles of Incorporation provide that you are “organized exclusively for charitable, religious, educational, and scientific purposes, the making of distributions to organizations that qualify as exempt organizations under section 501(c)(3) of the Internal Revenue Code, or corresponding section of any future federal tax code.” Your Form 1023 Application, describes your activities as follows: “At [you] we will offer average people in debt a membership that helps them control their Financial problems. We will offer Debt Management and Financial planning services through our membership program. We also would like to speak with high school students about Financial planning before they leave school.”

The information and materials you submitted, indicate that your primary activity will be the sale of debt management plans (DMPs) through two membership options: Plan One offers your services for a set-up charge of a $150 membership fee, a bi-monthly payment of $30 starting in month 3 along with the member’s regular payments to creditors; Plan Two offers your services for a set-up charge of a $100 membership fee the first month with a second installment of $65 due the second month a bi-monthly payment of $30 along with the member’s regular payments starting the third month.
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Your “Business and Marketing Plan” stated that you will advertise and market your DMP services through the internet, television, print media, radio, direct mail, and participation coupons. With regard to your expected market share you made the following statement: “We expect that market to grow as direct result of the jobs that have been lost in our country over the past two years. We plan to show our members how to better use the financial resources they already have. Our target for the end of our second year of business is at between 1% and 5% of the market.” You further stated the following with regard to your marketing objectives: “(1) Increase size of membership base; (2) Become a preferred assistant in financial planning, financial management, and debt management services; and (3) Take business from industry leaders that are not increasing financial stability.”

Your “Business Plan” clearly indicates that the sale of your DMP services will be directed to the general public. You state: “With our prices we believe we are helping all income levels, by giving them the flexibility to pay what they are able to the first month. We do not ask our members for monthly payments however we do require a bi-monthly to assist with operating cost.” Moreover, in your website you have made the following statement to the general public in attempting to promote the “benefits to repaying” debts through your program: “We can negotiate on your behalf with national and local creditors to reduce monthly payments by as much as 40%; Collection calls will stop; Depending on creditor, often interest charges, late charges and over limit fees can be reduced or eliminated; Throughout the program [we] will assist you in re- establishing a positive credit rating.”

Apart from your “business plan”, you have provided no specific, detailed information on any planned educational program with an educational methodology, including workshops or seminars directed to individuals, students or the general public on credit education issues. You have not indicated when, where or how you would conduct any such activities. Your “business” plan does not specifically address these concerns.

In letters dated October 20, 2003 and February 9, 2004, we requested that you provide detailed responses to questions concerning counselor certification, job descriptions, ownership interests in other businesses, compensation arrangements, business licensing, insurance, etc. Your responses to those questions were either incomplete or not answered.

In your Form 1023 Application, page 8, you have failed to provide a proposed budget showing your anticipated expenses. You did, however, provide a sheet showing “cash flow projections” as part of your “business and marketing plan.” You did not indicate that you would make any specific expenditure to charitable and educational programs or activities. Furthermore, you have not shown that you will receive revenue from sources other than fees for the sale of your DMP services.

Section 501(c)(3) of the Code exempts from federal income tax corporations organized and operated exclusively for charitable, educational, and other purposes, provided that no part of its net earnings inures to the benefit of any private shareholder or individual.

Section 1.501(c)(3)-1(a)(1) of the Income Tax Regulations provides that, in order to be exempt as an organization described in section 501(c)(3), an organization must be both organized and operated exclusively for one or more of the purposes specified in such section. If an organization fails to meet either the organizational test or the operational test, it is not exempt. 5

Section 1.501(c)(3)-1(c)(1) of the regulations provides that an organization will be regarded as “operated exclusively” for one or more exempt purposes only if it engages primarily in activities that accomplish one or more of such exempt purposes specified in section 501(c)(3). An organization will not be so regarded if more than an insubstantial part of its activities is not in furtherance of an exempt purpose.

Section 1.501(c)(3)-1(d)(1)(ii) of the regulations assigns the burden of proof to an applicant organization to show that it serves a public rather than a private interest and specifically that it is not organized or operated for the benefit of private interests, such as designated individuals, the creator or his family, shareholders of the organization, or persons controlled, directly or indirectly, by such private interests.

Section 1.501(c)(3)-1(d)(2) of the regulations provides that the term “charitable” is used in section 501(c)(3) of the Code in its generally accepted legal sense and includes the relief of the poor and distressed or of the under privileged as well as the advancement of education.

Section 1.501(c)(3)-1(d)(3) of the regulations provides that the term “educational” refers to:

(a) The instruction or training of the individual for the purpose of improving or developing his capabilities; or
(b) The instruction of the public on subjects useful to the individual and beneficial to the community.

Section 1.501(c)(3)-1(e)(1) of the regulations provides that an organization may meet the requirements of section 501(c)(3) although it operates a trade or business as a substantial part of its activities, if the operation of such trade or business is in furtherance of the organization’s exempt purpose or purposes and if the organization is not organized or operated for the primary purposes of carrying on an unrelated trade or business.

In American Institute for Economic Research v. United States, 302 F. 2d 934 (Ct. Cl.
1962), the Court considered an organization that provided analyses of securities and industries and of the economic climate in general. It sold subscriptions to various periodicals and services providing advice for purchases of individual securities. The court noted that education is a broad concept, and assumed arguendo that the organization had an educational purpose. However, the totality of the organization’s activities, which included the sale of many publications as well as the sale of advice for a fee to individuals, were indicative of a business. Therefore, the court held that the organization had a significant non-exempt commercial purpose that was not incidental to the educational purpose, and was not entitled to be regarded as exempt.

In Consumer Credit Counseling Service of Alabama, Inc. v. United States, 78-2 U.S.T.C.
9660 (D.D.C. 1978), the court held that an organization that provided free information on budgeting, buying practices, and the sound use of consumer credit qualified for exemption from income tax because its activities were charitable and educational.

The Consumer Credit Counseling Service of Alabama is an umbrella organization made up of numerous credit counseling service agencies. These agencies provided information to the general public through the use of speakers, films, and publications on the subjects of budgeting, 6

buying practices, and the sound use of consumer credit. They also provided counseling on budgeting and the appropriate use of consumer credit to debt-distressed individuals and families. They did not limit these services to low-income individuals and families, but they did provide such services free of charge. As an adjunct to the counseling function, they offered a dept management plan. Approximately 12 percent of a professional counselor’s time was applied to the dept management plan as opposed to education. The agencies charged a nominal fee of up to $10 per month for the dept management plan. This fee was waived in instances when payment of the fee would work a financial hardship.

The agencies received the bulk of their support from government and private foundation grants, contributions, and assistance from labor agencies and the United Way. An incidental amount of their revenue was from service fees.

The court found the organizations exempt under section 501(c)(3) because providing information to the public regarding the sound use of consumer credit is charitable in that it advances and promotes education and social welfare. These programs were also educational because they instructed the public on subjects useful to the individual and beneficial to the community. The counseling assistance programs were likewise charitable and educational in nature. Because the community education and counseling assistance programs were the agencies’ primary activities, the agencies were organized and operated for charitable and educational purposes. The court also concluded that the limited debt management services were an integral part of the agencies’ counseling function, and thus charitable, but stated further that even if this were not the case, these activities were incidental to the agencies’ principal functions.

Finally, the court found that the law did not require that an organization must perform its exempt functions solely for the benefit of low-income individuals to qualify under section 501(c)(3) or to provide its services solely without charge. Nonetheless, these agencies did not charge a fee for the programs that constituted their principal activities. They charged nominal fees for services that were incidental. Moreover, even this nominal fee was waived when payment would work a financial hardship.

In Easter House v. U.S., 12 Ct. Cl. 476 (1987), aff’d 846 F. 2d 78 (Fed. Cir 1988), the court found that adoption services were the primary activity of the organization. In deciding that the organization conducted adoption services for a business purpose rather for a charitable purpose, the court considered the manner in which the organization operated. The record established a number of factors that characterize a commercial activity and which were evident in the operations of Easter House also. The court determined that the organization competed with other commercial organizations providing similar services; fees were the only source of revenue; it accumulated very substantial profits, because it set its fees in order to generate a profit; the accumulated capital was substantially greater than the amounts spent on charitable and educational activity; and the organization did not solicit and did not plan to solicit contributions. The court also found a corporate-type structure in the classes of memberships (including a single life member having inherent power that the holder could transfer like stock), and dependence on paid employees.

In Rev. Rul. 69-441, 1969-2 C.B. 115, the Service found that a nonprofit organization formed to help reduce personal bankruptcy by informing the public on personal money management and aiding low-income individuals and families with financial problems was 7

exempt under section 501(c)(3) of the Code. Its Board of Directors was comprised of representatives from religious organizations, civic groups, labor unions, business groups, and educational institutions.

The organization provided information to the public on budgeting, buying practices, and the sound use of consumer credit through the use of films, speakers, and publications. It aided low- income individuals and families who have financial problems by providing them with individual counseling, and if necessary, by establishing budget plans. Under the budget plan, the debtor voluntarily made fixed payments to the organization, holding the funds in a trust account and disbursing the funds on a partial payment basis to the creditors. The organization did not charge fees for counseling services or proration services. The debtor received full credit against his debts for all amounts paid. The organization did not make loans to debtors or negotiate loans on their behalf. Finally, the organization relied upon contributions, primarily from the creditors participating in the organization’s budget plans, for its support.

The Service found that, by aiding low-income individuals and families who have financial problems and by providing, without charge, counseling and a means for the orderly discharge of indebtedness, the organization was relieving the poor and distressed. Moreover, by providing the public with information on budgeting, buying practices, and the sound use of consumer credit, the organization was instructing the public on subjects useful to the individual and beneficial to the community. Thus, the organization was exempt from federal income tax under section 501(c)(3) of the Code.

Outside the context of credit counseling, individual counseling has, in a number of instances, been held to be a tax-exempt charitable activity. Rev. Rul. 78-99, 1978-1 C.B. 152 (free individual and group counseling of widows); Rev. Rul. 76-205, 1976-1 C.B. 154 (free counseling and English instruction for immigrants); Rev. Rul. 73-569, 1973-2 C.B. 179 (free counseling to pregnant women); Rev. Rul. 70-590, 1970-2 C.B. 116 (clinic to help users of mind-altering drugs); Rev. Rul. 70-640, 1970-2 C.B. 117 (free marriage counseling); Rev. Rul. 68-71, 1968-1 C.B.249 (career planning education through free vocational counseling and publications sold at a nominal charge). Overwhelmingly, the counseling activities described in these rulings were provided free, and the organizations were supported by contributions from the public.

Rev. Proc. 90-27, 1990-1 C.B. 514, provides in part that exempt status will be recognized in advance of operations if proposed operations can be described in sufficient detail to permit a conclusion that the organization will clearly meet the particular requirements of the section under which exemption is claimed. A mere statement of purposes or a statement that proposed activities will be in furtherance of such purposes will not satisfy this requirement. The organization must fully describe the activities in which it expects to engage, including the standards, criteria, procedures, or other means adopted or planned, and the nature of the contemplated expenditures. Where the organization cannot demonstrate to the satisfaction of the Service that its proposed activities will be exempt, a record of actual operations may be required before a ruling or determination letter will be issued.

An organization must establish through the administrative record that it operates as a section 501(c)(3) organization. Denial of exemption may be based solely upon failure to provide information describing in adequate detail how the operational test will be met. American Science Foundation v. Commissioner, T.C. Memo. 1986-556; La Verdad v. Commissioner, 82 8

T.C. 215, 219 (1984); Pius XII Academy v. Commissioner, T.C. Memo. 1982-97. Exempt status can be recognized in advance of operations if proposed operations can be described in enough detail to permit a conclusion that the organization will clearly meet the requirements of section 501(c)(3). American Science Foundation v. Commissioner, T.C. Memo. 1986-556. The organization has the burden of providing sufficient documentation or other substantive information regarding its activities and operations, which would establish entitlement to tax- exempt status. Information that is vague or nonspecific is not sufficient to meet the requirements under section 501(c)(3). Tully v. Commisioner, T.C. Memo, 1999-216.

Our analysis of the information you submitted shows that while you are organized for charitable purposes, you do not satisfy the operational requirements to be recognized as exempt under section 501(c)(3) of the Code. There is no evidence that your primary purpose is to provide financial education to individuals or to the general public. You do not have a tailored education program with a structured educational methodology in place. In fact, the administrative record demonstrates that you operate for the substantial non-exempt purpose of operating a commercial business, which serves to further your private financial interests.

That you will be operated in the manner of a commercial business is reflected in the fact that your revenue will come exclusively from fees charged to clients for enrollment in either of your two DMP programs. In your June 2003 “Business and Marketing Plan”, you made clear your desire to have a profitable business operation, when you said the following: “Our target for the end of our second year of business is at between 1% and 5% of the market.” Moreover, in your “business plan”, you made clear your intent to sell and market your DMP services to the general public when you stated: “With our prices we believe we are helping all income levels.” In addition, in your website, you further promote and market the “benefits” of buying your services when you claim that you can get potential clients reduced payment and interest rates from creditors. The language you used in your “Business and Marketing Plan”, in your website and elsewhere, is clearly of the kind used by any commercial business attempting to promote and sell its products and/or services.

You have stated that you will advertise and market the availability of your services over the Internet, through television, print media, radio, direct mail and participation coupons. These methods of advertising are the kind commonly used by ordinary for-profit credit counseling businesses. Moreover, your proposed budgets show that you do not anticipate making any expenditures, including grants and contributions, to educational or charitable programs.

You have also failed to provide any evidence that your DMP program will be an incidental adjunct to a substantial and substantive program of public education and individual counseling. You have submitted no evidence that you will meet the requirements of operating a substantial and substantive program of public education or a course of individual counseling with a bona fide educational methodology. You have failed to substantiate that you follow an educational methodology in operating your DMP program. In fact, you have provided no materials that indicate you will have a substantive on-going educational program directed to the individuals and families you serve in your DMP. The limited materials you submitted were prepared primarily for your use in promoting and selling DMPs to potential clients.

You have provided no specific, detailed evidence of when, where or how you will conduct “credit counseling” seminars and/or workshops directed to the general community. Moreover, you have not provided substantial evidence that you will restrict your debt management services 9

to low-income customers. If you do have “low-income limits” for participation in your debt management program, you have provided no evidence of the specific guidelines that participants are required to meet. You have provided no advertising materials stating that your services will be restricted to low-income individuals and/or families. In fact, the information you provided indicates that your services will be available to the general public without regard to individual or family income.

Rev. Proc. 90-27 requires an applicant to submit sufficient information during the application process for the Service to conclude that the organization is in compliance with the organizational and operational requirements of section 501(c)(3) before a ruling is issued. You have not sufficiently and fully described your activities as they relate to the number of people you expect to enroll in your DMP and other financial services programs, where, when or how you would “educate” these individuals and families, or provided evidence that you will have a substantive and substantial education program tailored to the specific needs of these individuals and families. Furthermore, you failed to fully and completely respond to the questions raised in our letters dated October 20, 2003 and February 9, 2004. The vague and nonspecific information and documentation you provided does not meet the burden of showing that your activities and operations are such that you are entitled to recognition of exemption under section 501(c)(3). See Tully, supra.

Accordingly, you do not qualify for exemption as an organization described in section 501(c)(3) of the Code and you must file federal income tax returns.

Contributions to you are not deductible under section 170 of the Code.

You have the right to file a protest if you believe this determination is incorrect. To protest, you must submit a statement of your views and fully explain your reasoning. You must submit the statement, signed by one of your officers, within 30 days from the date of this letter. We will consider your statement and decide if the information affects our determination

You also have a right to request a conference to discuss your protest. This request should be made when you file your protest statement. An attorney, certified public accountant, or an individual enrolled to practice before the Internal Revenue Service may represent you. If you want representation during the conference procedures, you must file a proper power of attorney, Form 2848, Power of Attorney and Declaration of Representative, if you have not already done so. For more information about representation, see Publication 947, Practice before the IRS and Power of Attorney. All forms and publications mentioned in this letter can be found at www.irs.gov, Forms and Publications.

If you do not intend to protest this determination, you do not need to take any further action.
If we do not hear from you within 30 days, we will issue a final adverse determination letter. That letter will provide information about filing tax returns and other matters.

Please send your protest statement, Form 2848 and any supporting documents to this address: 10

Internal Revenue Service
TE/GE (SE:T:EO:RA:T:1)
Danny Smith
1111 Constitution Ave, N.W.
Washington, DC 20224

You may also fax your statement using the fax number shown in the heading of this letter.
If you fax your statement, please call the person identified in the heading of this letter to confirm that he or she received your fax.

If you have any questions, please contact the person whose name and telephone number are shown in the heading of this letter.

Sincerely,

Lois G. Lerner
Director, Exempt Organizations
Rulings & Agreements