Determination 1132030: IRS revoked a credit counseling organization's section 501(c)(3) exemption

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Plain-English summary

The IRS revoked the organization's section 501(c)(3) exemption, effective January 1, 2001, and concluded that contributions to it were not deductible under section 170. The organization offered telephone and face-to-face credit counseling and debt management plans, but the IRS found that counselors screened callers to enroll debt management clients and were evaluated and compensated based on production and retention. Fair-share payments from creditors were the organization's primary income, while a related for-profit service provider handled processing under per-client contracts. The IRS concluded that the organization was not operated exclusively for exempt purposes, served private rather than public interests, and allowed earnings to inure to private individuals. The determination also records that the organization later merged and considered itself terminated.

Ruling snapshot

• Question: Was the organization operated exclusively for section 501(c)(3) purposes, and did private benefit or inurement require revocation?
• Outcome: revocation
• Key authorities: IRC §§ 501(a), 501(c)(3), 170, 509(a)(2), 6104(c), and 7428; 15 U.S.C. §§ 1679, 1679a, and 1679b; Treas. Reg. §§ 1.501(c)(3)-1(a)(1), 1.501(c)(3)-1(c)(1), 1.501(c)(3)-1(d)(1), 1.501(c)(3)-1(d)(2), 1.501(c)(3)-1(d)(3), and 1.501(a)-1(c)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Appeals Office
1375 E. Ninth Street, Suite 815 Person to Contact:

Cleveland, OH 44114-1739
: Employee ID Number:

Tel:
Fax:
Number: 201132030 Refer Reply to:
Release Date: 8/12/2011
In Re:
Date: May 19, 2011 Tax Period(s) Ended:
A Form Required to be Filed:
B Employer Identification Number:
UIL:
501.03-08
Certified Mail
Dear

This is a final adverse determination as to your exempt status under section 501(c)(3) of
the Internal Revenue Code (IRC). It is determined that you do not qualify as exempt
from Federal income tax under Section 501(c)(3) of the Internal Revenue Code,
effective January 1, 2001.

Our adverse determination was made for the following reason(s):

You are not operated for an exclusive exempt purpose as is required by Internal
Revenue Code section 501(c)(3). You operate substantially for non-exempt
purposes. In addition, you operate for substantial private, rather than public,

purpose.
Contributions to your organization are not deductible under Code section 170.

You are required to file Federal income tax returns on the form indicated above. You
should file these returns within 30 days from the date of this letter, unless a request for
an extension of time is granted. File the returns in accordance with their instructions,
and do not send them to this office. Processing of income tax returns and assessment
of any taxes due will not be delayed because you have filed a petition for declaratory
judgment under Code section 7428.

If you decide to contest this determination under the declaratory judgment provisions of
Code section 7428, a petition to the United States Tax Court, the United States Court of
Claims, or the district court of the United States for the District of Columbia must be filed

within 90 days from the date this determination was mailed to you. Contact the clerk of
the appropriate court for rules for filing petitions for declaratory judgment. To secure a
petition form from the United States Tax Court, write to the United States Tax Court,
400 Second Street, N.W., Washington, D.C. 20217.

We will notify the appropriate State officials of this action, as required by Code section
6104(c). 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, please contact the person whose name and telephone
number are shown in the heading of this letter.

Sincerely, .
Karen A. Skinder
Appeals Team Manager

DEPARTMENT OF THE TREASURY
Internal Revenue Service

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

July 25, 2005

Taxpayer Identification Number:
Form:

Tax Year(s) Ended:

Person to Contact/ID Number:

Contact Numbers:
Telephone:
Fax:

Certified Mail - Return Receipt Requested

Dear

We have enclosed a copy of our report of examination explaining why we believe
revocation of your exempt status under section 501(c)(3) of the Internal Revenue Code
(Code) is necessary.

If you accept our findings, take no further action. We will issue a final revocation letter.

If you do not agree with our proposed revocation, you must submit to us a written
request for Appeals Office consideration within 30 days from the date of this letter to
protest our decision. Your protest should include a statement of the facts, the
applicable law, and arguments in support of your position.

An Appeals officer will review your case. The Appeals office is independent of the
Director, EO Examinations. The Appeals Office resolves most disputes informally and
promptly. The enclosed Publication 3498, The Examination Process, and Publication
892, Exempt Organizations Appeal Procedures for Unagreed Issues, explain how to
appeal an Internal Revenue Service (IRS) decision. Publication 3498 also includes
information on your rights as a taxpayer and the IRS collection process.

You may also request that we refer this matter for technical advice as explained in
Publication 892. If we issue a determination letter to you based on technical advice, no
further administrative appeal is available to you within the IRS regarding the issue that
was the subject of the technical advice.

Letter 3618 (04-2002)
Catalog Number 34809F

If we do not hear from you within 30 days from the date of this letter, we will process
your case based on the recommendations shown in the report of examination. If you do
not protest this proposed determination within 30 days from the date of this letter, the
IRS will consider it to be a failure to exhaust your available administrative remedies.
Section 7428(b)(2) of the Code provides, in part: "A declaratory judgment or decree
under this section shall not be issued in any proceeding unless the Tax Court, the
Claims Court, or the District Court of the United States for the District of Columbia
determines that the organization involved has exhausted its administrative remedies
within the Internal Revenue Service." We will then issue a final revocation letter. We
will also notify the appropriate state officials of the revocation in accordance with section
6104(c) of the Code.

You have the right to contact the office of the Taxpayer Advocate. Taxpayer Advocate
assistance is not a substitute for established IRS procedures, such as the formal
appeals process. The Taxpayer Advocate cannot reverse a legally correct tax
determination, or extend the time fixed by law that you have to file a petition in a United
States court. The Taxpayer Advocate can, however, see that a tax matter that may not
have been resolved through normal channels gets prompt and proper handling. You
may call toll-free 1-877-777-4778 and ask for Taxpayer Advocate Assistance. If you
prefer, you may contact your local Taxpayer Advocate at:

If you have any questions, please call the contact person at the telephone number
shown in the heading of this letter. If you write, please provide a telephone number and
the most convenient time to call if we need to contact you.

Thank you for your cooperation.

Sincerely,

R.C. Johnson
Director, EO Examinations

Enclosures:
Publication 892
Publication 3498
Report of Examination

Letter 3618 (04-2002)
Catalog Number 34809F

Form 886-A

Exhibit I

XXXXXK
SUCCESSOR — XXXXX
TAX YEARS ENDING XXXXX

ISSUES

Whether XXXXX is operated exclusively for exempt purposes described within Internal
Revenue Code section 501(c)(3):

Whether more than an insubstantial part of XXXXX’S activities is in furtherance of a
non-exempt purpose?

Whether XXXXX was operated for the purpose of serving a private benefit rather than
public interests?

Whether any part of the net earnings of XXXXX inured to the benefit of any private
shareholder or individual?

Should the tax-exempt status of XXXXX be revoked for failure to operate exclusively for
501(c)(3) purposes and for violating the prohibition on inurement as set forth in Internal
Revenue Code section 501(c)(3)?

Form 886-A

Exhibit I
FACTS

History of Control

XXXXX of XXXXX, was the Director and Chief Executive Officer of XXXXX (XXXXX)
during XXXXX, the years under examination. He is also a founding member of the
XXXXX (XXXXX).

XXXXxX originally established XXXXX (XXXXX) dba XXXXX as a for-profit corporation,
incorporated XXXXX under the laws of the State of XXXXX. It provided services for
XXXXX’s (XXXXX's) parent XXXXX (XXXXX) dba XXXXX, a nonprofit corporation
incorporated XXXXX in XXXXX as well as other independent credit counseling
agencies. XXXXX was President of XXXXX (XXXXX) dba XXXXX during XXXXX, the
years under examination.

XXXXX (XXXXX) dba XXXXX had acquired the stock of XXXXX in XXXXX from XXXXX
(50%) and XXXXX (50%). XXXXX had also acquired the stock of XXXXX(XXXXX) in
XXXXX from XXXXX (30%), XXXXX (30%), and XXXXX (40%) who also works as a
leased data processing employee for XXXXX. XXXXX had merged with XXXXX and
the surviving corporation XXXXX became a wholly-owned for-profit subsidiary of
XXXXX. XXXXX (XXXXX) dba XXXXX also took control of the board of XXXXX in
XXXXX. XXOXKXX and Affiliates prepared consolidated financial statements for the years
ended XXXXX.

XXXXX (XXXXX) and XXXXX (XXXXX) both of XXXXX had engaged XXXXX (XXXXX)
dba XXXXX to process and provide ongoing support to XXXXX/XXXXX debt
consolidation clients at a rate of $17 per month per active client for its services.
XXXXX/XXXXX was seeking to avoid a financially-challenging long-term commitment
on debt management program activities, and agreed to transfer 375 credit
counseling/debt consolidation clients to the newly incorporated XXXXX (XXXXX) for
assumption of XXXXX service fee debt owed to XXXXX.

XXXXX (XXXXX) was incorporated XXXXX under the laws of the State of XXXXX as a
nonprofit public benefit corporation. In its Articles of Incorporation, XXXXX stated its
specific charitable and public purposes of the corporation are:

(a) to provide for instruction, training, and counseling of individuals on consumer
credit problems and family budgets,

(b) to advise and mediate terms of repayment with the creditors of individuals
experiencing financial difficulties, and

(c) to educate the public on issues related to personal financial management

Form 886-A

Exhibit I

In its Articles of Incorporation filed XXXXX, XXXXX stated that organization’s property is
irrevocably dedicated to charitable purposes, and no part of the net income or assets of
this corporation shall ever inure to the benefit of any director, officer, or member of this
corporation or to the benefit of any private individual.

On XXXXX, XXXXX entered an agreement to assume the ongoing credit counseling
activities operated by XXXXX (XXXXX) of XXXXX. XXXXX transferred assets to
XXXXX along with the existing Debt Management Plan client base of 375 active clients.
XXXXX no longer desired to continue credit counseling/debt consolidation services
because the cost of services by XXXXX (XXXXX) dba XXXXX caused XXXXX to lose
money every month. XXXXX paid XXXXX $17 per month per active client for its
services. XXXXX agreed to assume the unpaid deferred service liability of $63,937 due
XXXXX for customer service, accounting, computer support, training, and other
servicing of XXXXX clients through XXXXX. XXXXX agreed to satisfy such debt out of
future earnings from the existing client base and pay XXXXxX thirty-five percent of gross
receipts (maintenance fees and fair share) attributed to those clients after XXXXX.

XXXXX intended to refer to XXXXX any of its housing counseling or other clients that
were eligible for and/or interested in debt consolidation program services. XXXXx still
refers people to XXXXX to help repair their credit and use the debt consolidation
services of XXXXX’s debt management program.

Secretary XXXXX submitted XXXXX's Form 1023 application for exemption under
section 501(c)(3) on XXXXX. The exemption application stated that the organization
was formed to provide education of the public on issues relating to household and/or
personal financial management, and to provide instruction and training of individuals for
the purpose of improving their capability in dealing with personal financial matters. The
Form 1023 Application improperly responded “no” regarding any contractual
agreements for management services. Form 1023 also omitted the unpaid deferred
service liability of $63,937 due XXXXX (XXXXX) dba XXXXX from its balance sheet.

The XXXXX directors held a Board Meeting XXXXX and decided to negotiate an
Agreement with XXXXX. The new agreement dated XXXXX was signed by XXXXX as
Chairman of the Board of XXXXX and XXXXX as Director of Operations for XXXXX.
The SERVICE AGREEMENT provided for a price of $18 per active client per month for
Data Processing, Funds Collection and Disbursement Services, Customer Service,
Management Information Support Services, Training, and Marketing. These processing
and support services applied to existing XXXXX/XXXXX clients and to the new clients
enrolled in debt management plans by XXXXX.

An IRS Determination Letter was issued in XXXXX for an advance ruling on exemption
under section 501(c)(3) and not a private foundation under 509(a)(2) until XXXXX.

In XXXXX, XXXXX's Board amended its By-Laws to require five Directors, thus adding
two. XXXXX agreed to this change. XXXXX said this was supposed to alleviate any
responsibilities for her or XXXXX. XXXXX and XXXXX were nominated by XXXXX and

Form 886-A

Exhibit I

XXXXX and were added to the Board XXXXX. XXXXX (XXXXX) and XXXXX (XXXXX
and XXXXxX) are brothers.

XXXXX's Agreement with XXXXX was amended effective XXXXX. An agreement was
reached for XXXXX, XXXXX, and XXXXxX to offer their resignations contingent upon
XXXXX dba XXXXX agreeing to satisfy payment terms of the XXXXX amended
agreement with XXXXX. Such terms included payment of $20,000 to XXXXX for
XXXXX's unpaid deferred service liability and payment of an additional $50,977 to
XXXXX for XXXXX’s unpaid debt and for an increase to the XXXXX full service monthly
fee to $18 for all active clients, hence agreement for sale of XXXXX.

Two directors XXXXX and XXXXX submitted signed resignations XXXXX. XXXXX
appointed new board members XXXXX, XXXXX, and XXXXX from XXXXX (XXXXX)
dba XXXXX prior to his resignation XXXXX. XXXXX and his wife XXXXX worked for
XXXXX as leased employees in XXXXX.

XXXXX and XXXXX were chief executives in XXXXX (XXXXX) dba XXXXX and XXXXX
became a controlled subsidiary of XXXXX and began using the XXXXX name, effective
XXXXX. There was not public control.

XXXXX was a counselor for XXXXX's XXXXX, XXXXX office and the required resident
of XXXXX on XXXXX's board of directors. XXXXX was hired by XXXXX in XXXXX who
was then Director of Operations for XXXXX. XXXXX took over XXXXX XXXXX Office,
effective XXXXX. XXXXX’s counseling evaluations for the last quarter of XXXXX were
Level 1 evaluations resulting in a proposed reduction in salary. XXXXX resigned
XXXXXX,

XXXXX was nominated and elected to the board XXXXX. XXXXX continued as a board
member until organization merged, but he indicated that he was not involved in
decision-making. XXXXX XXXXX and XXXXX, management of XXXXX, controlled the
board.

XXXXX dba XXXXX, XXXXX, and XXXXX dba XXXXX (which merged in XXXXX with
XXXXX,) merged, effective XXXXX. The surviving corporation is XXXXX, a nonprofit
corporation in XXXXX governed by XXXXX as President and XXXXX as Chief Financial
Officer and their designees.

A March 24, 2004 United States Senate Subcommittee Report entitled “Profiteering in a
Non-Profit industry: Abusive Practices in Credit Counseling” states that tax-exempt
organizations were founded as call centers for the purpose of referring business to
for-profit service providers. XXXXX was one of several exempt organizations that
signed fulfillment agreements with XXXXX (XXXXX) dba XXXXX, through which XXXXX
performed all of the processing services for the exempt organizations and collected
substantial fees for its services.

Historical Activities

Form 886-A
Exhibit I

In its Internal Revenue Service Form 1023, application for exempt status submitted
XXXXX, XXXXX stated that its activities would provide education of the public on issues
relating to household and/or personal financial management, and to provide instruction
and training of individuals for the purpose of improving their capability in dealing with
personal financial matters. Activities included the following:

(a) Budget analysis

(b) Income verification

(c) Analysis of secured and unsecured debt

(d) Development of a financial plan for the individual

Other activities to be performed included educational seminars or educational forums
for the public on budgetary, credit, and money management issues.

XXXXX operated counseling offices and call centers in XXXXX, XXXXX, and XXXXX,
XXXXX for XXXXX, whose purpose was to restore financial balance to people's lives.
In some cases, counseling and DMP clients were referred by XXXXX and XXXXX.
Consultants were required to handle leads, develop action plans, and enroll certain
clients and retain them beyond 90 days in debt management plans (DMPs). If a DMP
did not apply, they could recommend a self administered plan and advise the individual
not to pay on their debts and to contact the counselor later so they could review the
situation again (and possibly qualify for a DMP after some change). They also advised
Chapter 7 bankruptcy.

The primary activity engaged in by XXXXX during the years XXXXX and XXXXX was
telephone consultation of any individuals in financial distress. Organization received
calls through the XXXXX telephone system and provided telephone consultation to
callers to determine the source of their financial problems. The organization also
engaged in face-to-face consultation and provided pamphlets, brochures, and books to
clients. Individuals were evaluated for and screened for the possibility of enrollment in
debt management plans (hereinafter DMPs).

Potential DMP clients were individuals with unsecured debt, primarily credit card debt.
A DMP is a program whereby a client makes monthly payments to XXXXX and its
affiliates to satisfy his/her unsecured debts over a 3-5 year period. Most of the debts
handled in a DMP were credit card debts, but other unsecured debts such as hospital
bills, student loans, tax debts, and payday loans were also managed through XXXXX

DMPs.

The consultants sought DMPs acceptable to the creditors to receive fair share
payments. They were also evaluated on retention of DMPs. E-mails and recordings
indicate that there were problems with DMPs being rejected by management of XXXXX
and its affiliates because DMPs that were rejected by creditors would affect XXXXX
experience with creditors and percentages of fair share payments. To receive fair
share payments, the organization fit into a system created by the creditors.

Form 886-A
Exhibit I

Call Center Counseling/Screening

In a typical call with a potential client, the employees introduce themselves as.
employees of XXXXX, a non-profit corporation, and advise that they can help restore
financial balance to the person’s life. XXXXX’s consultants were instructed to collect
accurate information from the client during the consultation session to include names
and addresses, home phone, work phone and fax, email address and social security
number. Consultants were trained to establish a clear purpose or motive for the
consultation, gather financial information and identify the problem, offer solutions for the
client's review, develop a detailed plan for implementation of a solution to resolve their
financial problem, and confirm that the solution fits the purpose. (CCP-75-01)
Consultants tell callers that they have helped thousands of clients in similar situations.
Employees ask clients how much income they have coming in each month, how much
their living expenses are (rent/utilities/telephone/food/etc) and how much is left that can
be used to pay bills. Employees enter the responses to the income and expense
questions on their computers. They advise that instead of clients paying individual
creditors, they will only have one payment to pay creditors. They further advise that a
debt management plan will pay the potential client's debts faster while eliminating
interest payments and late fees and putting an end to harassing phone calls.
Employees go down the list by creditor name, credit type (credit card/auto loan,
secured/unsecured), total debt balances, whether current or late, and use creditor
provided minimum balance tables to arrive at a proposed payment. Employees mail a
Client Action Plan with an agreement document and an “Authorization to Release
Information” document to the client to complete and mail back to the employee.
Education

In addition to its DMP activities, the organization engaged in nominal education and
outreach presentations. In XXXXX and XXXXX organization did not have a coordinated
educational workshop or seminar program. There were several presentations about the
effects of financial crisis on homeowners conducted by XXXXX in XXXXX in XXXXX,
XXXXX for the Homecomings program. In addition, XXXXX's Chief Executive Officer
XXXXX XOXOXXX made presentations on dealing with debt crisis and fundamentals of
budgeting and credit in March and April XXXXX in XXXXX, XXXXX and at a University
of XXXXX campus on behalf of XXXXX. XXXXX indicated that “the XXXXX counselors
were discouraged from conducting workshops in XXXXX as XXXXX management was
concerned about the quality of any presentation.” Also the staff participated in a
conference at the local college for incoming students in XXXXX, but

“no detailed records were maintained.” Organization concentrated on one-on-one
counseling and education in its offices and over the telephone from its call centers.

The following table illustrates a comparison of XXXXX activities to those of other
exempt credit counseling organizations:

Form 886-A

Exhibit I
TAX-EXEMPT CREDIT COUNSELING ORGANIZATIONS
XXXXX _ Rev. Rul. Rev. Rul. XXXXX
Alabama 69-441 65-229
501(c)(3) 501(c)(4)
Free Public Yes: Major Yes No - Yes, Nominal
Education activity
Free Individual Yes: Major Yes Yes Yes
Counseling activity
Debt Yes: 12% of Yes Yes Yes
Management counselors’ time
Plans
Fees for DMPs Yes: nominal No Yes: nominal Yes:
waived for waived for
hardship hardship
Amount of Incidental None Minor: main XXXXX - 43%
Revenue from amount support from XXXXX - 46%
Fees Fair share and main support
contributions | from Fair share
Public Support Contributions Some: amount | Some: amount No, only
from gov't, not specified not specified fair share and
private found., & enrolled clients
United Way
Community 60% from All members n/a n/a — Board of
Board general public represent the Parent Reps.
public and Employee
Finances

Fair share payments from creditors represent the organization's primary income. Fair
share payments ranged from 5 to 10 percent of amounts collected on the creditors
behalf. Each creditor has a rate of payment based upon their DMP experience. XXXXX
received fair share in two ways: (1) by deducting fair share from amounts collected and
remitted to credit card companies and (2) by billing the credit card companies.

It recognized uncollectible fair share billings as bad debt expense.

In XXXXX XXXXX earned revenues of $
. In XXXXX XXXXX earned revenues of $

of total XXXXX revenues of $
in fair share representing 54 percent of total XXXXX revenues of $

in fair share representing 57 percent

The following Exhibit illustrates income and expenses reported on XXXXX Forms 990
and detail per Examination:

XXXXX XXXXX XXXXX XXXXKX XXXXX

Form 886-A

Exhibit I
Form Form Form Form Form
990 990 990 990 990
Direct public support 0 0 0 0 0)
Program service revenue
Fair Share - from Creditors
Processing fees - from Clients
Enrollment fees - from Clients
Other income * XXXXX Oo * 0 0

Total Revenue

Compensation of Officers 0 0
Salaries and Wages
Service Bureau Expense

Bad Debts 6) 0
Occupancy 0
Telephone

General and Administrative 0

Other Expenses

Total Expenses

Excess or (Deficit)

Although XXXXX experienced annual financial losses, it continued to expand its
activities to attract and retain DMPs, its collections on behalf of creditors, its contracting
with the for-profit service provider XXXXX, and payment of service bureau fees.

When on a DMP, the client usually was required to pay a $25 enrollment fee and a
monthly maintenance fee for the service. The maintenance (processing) fee varied
depending on the amount of the payments. It was generally based upon 6.5 — 8.0
percent of the payments and usually ranged from $0 to $35 per month. Of XXXXX
Revenues, XXXXX received 43 percent from clients with monthly maintenance of

$ and enrollment fees of $ . In XXXXX, XXXXX received 46 percent in
revenues with client maintenance of $ and enrollment fees of $

More than an insubstantial part of XXXXX's activities was directed towards referring
business to the for-profit service provider XXXXX, which was operated by XXXXX, Chief
Financial Officer of XXXXX and Chief Operating Officer of XXXXX and as a
wholly-owned subsidiary of the non-profit parent XXXXX, exempt under 501(c)(3).

Revenue Agent determined that XXXXX Service Bureau Expense of $' included
$ paid to XXXXX and $ paid in revenue sharing for XXXXX clients to
XXXXX. Of XXXXX Revenues XXXXX paid 48 percent to XXXXX. Revenue Agent
determined that XXXXX Service Bureau Expense of $. included $ paid

Form 886-A

Exhibit I

to XXXXX and $ paid in revenue sharing to XXXXX. Of XXXXX Revenues XXXXX
paid 57 percent to XXXXX. The annual losses did not deter DMP enrollments with
XXXKXX.

In XXXXX and XXXXX, XXXXX and XXXXX were controlling officers of XXXXX and
controlled XXXXX’s and XXXXX’s daily operations. XXXXX’s officers XXXXX and
XXXXX did not receive compensation directly from XXXXX. However, XXXXX’s Forms
990 reported that XXXXX received salaries of $ in XXXXX and $ in
XXXXX. XXXXX’s Forms 990 reported that XXXXX received salaries of $ in
XXXXX and §$ in XXXXX. XXXXX also paid XXXXX equal amounts, which would
result in compensation of XXXXX of $ in XXXXX and $ in XXXXX from
both XXXXX and XXXXX.

Marketing and Advertisements

XXXXX engaged commercial practices to pursue revenues. It employed advertising,
business methods, and pricing to attract and retain clients. XXXXX received calls from
potential clients responding to advertising in a number of media including telephone
book yellow page ads, newspapers, and websites. Most contacts with clients were by
phone, e-mail, and U.S. mail. Some contacts also were made at offices through
“walk-ins.” XXXXX received referrals from XXXXX/XXXXX. XXXXX also purchased
leads on behalf of all XXXXX branches, and XXXXX consultants were evaluated on
“leads handled.” XXXXX also paid for advertising in various media including telephone
book yellow pages and newspapers in XXXXX.

A XXXXX telephone book yellow pages advertisement reads:

~ A Non-profit Agency ~ XXXXXX XXXXX ~ Call Now! : XXXXX ~
XXXXX, XXXXX.

Revenue Agent secured seven other samples of yellow pages advertisements for the
XXXXX, XXXKXX office, which contained very similar wording and consumer calls to
action.

A XXXXX ad read:

. Free consultation call XXXXX XXXXX.

A XXXXX XXXXX advertisement starting XXXXX read:

XXXXX. XXXXX or toll free XXXXX.

Form 886-A
Exhibit I

XXXXX advertised its services on its website, XXXXX. It also had two brochures, in
which it advertised its services to the general public, a and
a brochure. The brochures are used to generate client interest in its
debt management program. In the brochure XXXXX claims: “XXXXX

’rogram that helps the consumer consolidate all unsecured debt. We

Consultation/Screening

Very little active budgeting education or budgeting assistance was offered to the callers.
Consultants gathered financial information to determine if individuals and the
organization may benefit from their debt management services. Consultants listen,
evaluate, and provide free advice, Client Action Plans, and possibly literature to callers
who would not benefit from, or qualify for, a DMP including callers without sufficient
ability to pay their debts after their living expenses.

XXXXX generally operated as follows: Contact with a potential client would be made by
telephone or e-mail. There was no pre-screening of leads based upon education,
income, or need to determine educational level or charitable class. Consultants would
ask probing questions to identify the purpose of the call and the root of the individual's
problems. Employee would counsel the individual, determine options, and offer
solutions to their problem. If the individual were a good candidate, the call would result
in an attempt to enroll the potential client in a Debt Management Plan. The employee
would ask the person for information regarding income, expenses, and unsecured debts
that the individual currently had. The employee would gather name, address, telephone
number, social security number, date of birth, occupation, and employment information.
The employee would then prepare a “Personal Information” worksheet and “Creditor
and Proposal Summary,” which contained such personal information and a list of all
debts to be covered by the plan. The Creditor and Proposal Summary would list the
creditor information, total debt, and proposed monthly payment.

On its XXXXX Form 990 XXXXX reported it “interviewed approximately 4,367
individuals” and 454 were enrolled ina DMP. On its XXXXX Form 990 XXXXX reported

It “interviewed approximately 9,753 individuals” and 975 were enrolled in a DMP during

the year.
XXXXX reported total clients under debt management at end of XXXXX was 758, and at

end of XXXXX, total was 1,273.

10

Form 886-A
Exhibit I

Client Action Plans

Client Action Plans (CAPs) included a greeting and information related to the
conversation with the individual caller. CAPs summarized the telephone conversation

as follows” '

.” It follows with boxes checked of the consultant's perception of the individual's
situation and recommendation based upon the consultant's understanding.

The choices for perception are as follows:

© Behind in unsecured debt © Emergency or unexpected expense
Reduction or loss of income © Supplementing income with credit
Q Family crisis/Personal crisis © Behind on secured debt or utilities
4 Other

The choices for consultant's recommendation include the following:

Q XXXXX — Debt Management Plan 0 Prioritization of debts/finances

Q Increase your income/reduce expenses Q Budgeting exercises

© Bankruptcy/Legal Counsel 6 Educational course

Q Self-administered plan © Repayment plan for mortgage

6 Referred to other service Q Pre-foreclosure/Short sale on mortgage
O Other

' Self-Administered Plan or Bankruptcy

Revenue Agent found that organization often referred individuals with insufficient
‘income to cover their living expenses to a self-administered plan or bankruptcy.
However, those who had sufficient income to cover living expenses and some
unsecured debts were generally referred to DMPs. It appears that the consultants
gather financial information to determine if individuals may benefit from a DMP and
would meet creditor specifications for acceptance to a DMP.

Client Action Plans were not widely used in XXXXX and XXXXX, however Revenue
Agent obtained some samples with XXXXX dates. One CAP for XXXXX stated that
perception of situation was 6 Emergency or Unexpected expenses and 4 Behind on
secured debt or utilities. It stated “First step is to contact your landlord. Second step is
to call the lease company that you have vehicle with and offer them a voluntary
repossession. Third step is to call Qwest and request them to stop automatic payment
and ask what they are willing to do as far as a payment plan. Fourth step would be to
call me back after you get all of these priorities taken care of so we can assist you with
all of your unsecured debts (personal loan, LOC, credit card).” Recommendation was
6 Self-administered plan and a Prioritization of debts/finances.

1]

Form 886-A

Exhibit I
Another.CAP recommending a 4 Self-administered plan to XXXXX and XXXXX stated
that their “current budget doesn’t reflect that you have the resources to start paying
down this debt.” XXXXX “recommendation is to simply ignore the collector and continue
to provide for your family.” The consultants also “included some information that will
likely help stop some of the collection efforts. When your husband finally gets a wage
increase | would recommend that you contact me so we can review your situation again
and determine the best plan to resolve the student loan.”

A CAP with a Behind in unsecured debt and a Other: collection calls recommends a a
Self-administered plan to XXXXX stated that “

Another CAP with o Behind in unsecured debt recommends a a Self-administered plan
for XXXXX indicating “

A CAP for XXXXX for 4 Reduction or loss of income the counselor recommended
© Bankruptcy/Legal Counsel and stated “

Debt Management Plans

Debt Management Plans (DMP) were marketed as providing benefits and a needed
bill-paying service to clients. The recommendation for the debt management program
as a solution advised the client that it would allow them to get control over their personal
debts by reducing the payment and interest rates, and most importantly reduce the
stress that their current financial situation was causing.

Based upon a review of some client information sheets, it does not appear that the
amount of disposable income in the “budget worksheet” necessarily bore any
relationship to the monthly payment required by the DMP; in one case available income
was $758 and proposed payment was $135.00. In another case, the client's monthly
available income after expenses of $565.00 was barely able to cover the proposed
monthly payment under the DMP in the amount of $564.00.

Written Client Action Plans were not widely used in XXXXX and XXXXX, however
Revenue Agent obtained some samples in XXXXX. One CAP indicated that a standard

Form 886-A

Exhibit I

debt management plan would require only one payment per month, lower their interest,
and provide the ability to rebuild their credit due to paying creditors as agreed. However
it would not reduce their monthly payments, and they could not use credit while on this
program. For example, OOK and XXXXX of XXXXX, XXXXX had a “

” The CAP stated “If

you can afford your current payments of about $6000 per month, this plan should work
well for you if your goal is to pay off debt. If you cannot afford a $6000 payment, there
may be another alternative we can discuss that would require much more effort on your
part but is capable of getting the payments down to about $3000 per month.” That CAP
was signed by XXXXX XXXXX, an officer of XXXXX.

Another CAP recommending an XXXXX-Debt Management Plan and Budgeting
exercises to XXXXX of XXXXxX stated '

” The CAP provides Applicant's net income of $300 and
expenses of $100 with $200 available income and a proposed DMP payment of $106.
A Client Authorization Agreement indicated that XXXXX could retain $8 (or $350 over
the term of this agreement) of a $106 monthly payment for 8.1% of $98 monthly
payment on $5,378 in debts. That CAP was signed by XXXXX, an officer of XXXXX.

XXXXX of XXXXX stated “

Another CAP for XXXXX and XXXXX without a ‘Perception of your situation” box
checked stated “

" It further had an “our recommendation for your situation” box checked
XXXXX- Debt Management Plan. It stated “

Account Management

Upon receipt of a completed DMP client information packet, counselors updated lead
tracking. Once a completed DMP packet was received, the counselor contacted the

13

Form 886-A

Exhibit I

client, confirmed their plans, and transitioned the client to Account Management
personnel with XXXXX (XXXXX).

When a customer agreed to a DMP, the individual signed an Agreement, which
provided for the monthly payments on the debt balances. It also provided for an
additional 10 percent over disclosed balances for undisclosed debts and service fees.

lf offered a DMP, the client usually was required to pay a $25 enrollment fee and a
monthly maintenance fee for the service. The maintenance (processing) fee varied
depending on the amount of the payments. It was generally based upon 6.5 — 8.0
percent of the payments and usually ranged from $0 to $35 per month.

The monthly payment made by the DMP client would ordinarily include a payment to
each creditor plus a maintenance fee for the DMP service.

For example, in XXXXX, XXXXX and XXXXX agreed that XXXXX could retain$ of

their $ monthly payment for 6.6% of $ debt payment on $ in debts. In
XXXXX XXXXX, XXXXX agreed that XXXXX could retain $10 of her $ monthly
payment for 8% of $ monthly payment on $ in debts.

In XXXXX XXXXX of XXXXX agreed to a monthly maintenance fee of $ of his $
monthly payment for 8.7% on $ in debt payments on balances of $ in debts.
XXXXX’s case was provided as an example of a XXXXX DMP client who achieved
reduced interest rates and other savings through the DMP.

For individuals agreeing to a DMP, the maximum maintenance fee was determined
based upon the state in which the clients reside. In XXXXX, XXXXX of XXXXX agreed
that XXXXX could retain only $ (XXXXX maximum) of his $ = monthly payment or
4.2% of $ payment on $ in debts. However, in 2003 XXXXX and XXXXX
from XXXXX were required to pay a monthly charge of $ _ of their $ monthly
payment for 6.8% of $ debt payment. Their debts were approximately $

The organization contracted the for-profit service provider XXXXX (XXXXX) dba XXXXX
for data processing services at a $17 - $18 monthly fee for each DMP client. XXXXX

Service Bureau Expense of$ included $ paid to XXXXX. XXXXX
Service Bureau Expense of $ included $. paid to XXXXX. With an
annual service bureau cost of $ per client for twelve ($18) months, service bureau
expenses of $ for XXXXX and $ for XXXXX indicate payment for 823

and 1,039 clients for twelve months in XXXXX and XXXXX, respectively.

Free Or Below Cost Services

While DMP services were not limited to low-income or the poor, some DMP clients had
their fees waived. XXXXX indicated that XXXXX had 84 of 454 clients enrolled in DMPs

at no charge in XXXXX, and 122 of 973 were enrolled at no charge in XXXXX. General
ledger enrollment fee income indicates that at least 421 paid $25 in XXXXX and at least

14

Form 886-A

Exhibit I

773 paid $25 in XXXXX. also indicated that 95 of 454 DMP clients and 198 of
973 DMP clients did not pay for monthly services in XXXXX and XXXXX, respectively.

However, some seemingly “low-income” clients were required to pay enrollment fees
and monthly maintenance charges. A long-term customer XXXXX with steady DMP
activity ranging from XXXXX to XXXXX indicated monthly income of only$ —_, monthly
expenses of$ ,and$ of available income and proposed DMP payment of $:

This DMP client had total debts of $ and an agreed total of $ ; was
required to pay a monthly maintenance charge of $18 of her $ monthly payment.
Her monthly maintenance charge was 8% of her monthly debt payment. case

was provided as an example of a XXXXX DMP client who achieved reduced interest
rates and other savings through the DMP.

XXXXX Client unable to pay Procedures (AMP-75-02) document discloses a system
and instructions on criteria for Account Management to use for evaluating accounts in
which clients are unable to afford or make the scheduled payments. There also
appears to be a grant/refund or temporary loan for clients who are in “true need and
through investigation and counseling determined to be a good risk and candidate for the
successful completion of the DMP.”

XXXXX management provided printouts of clients whose enrollment fees and/or
maintenance fees were waived in XXXXX and XXXXX. The printouts showed that most
individuals who enrolled with the fee waived also dropped from the DMPs. The most
recent date dropped was in XXXXX.

XXXXX sometimes provided DMP services below its cost. For individuals agreeing to a
DMP, XXXXX/XXXXX and XXXXX sometimes charged the individuals monthly
maintenance fees less than the $17 or $18 per month paid on the XXXXX contracts.
Also, some maintenance fees were waived, but XXXXX still paid XXXXX a monthly fee.
In substance the creditors’ fair share payments helped to pay the for-profit's service
charges in violation with the credit card companies’ requirement that fair share only be
paid to organizations exempt under section 501(c)(3).

For example, a XXXXX Customer Authorization Agreement indicates a XXXXX/XXXXX
Client XXXXX agreed that XXXXX could retain $13 of her $173 monthly payment to
XXXXX. Her debts were approximately $ . In XXXXX clients XXXXX and XXXXX
agreed that XXXXX could retain$ of $ monthly payment to XXXXX. In February
XXXXX client XXXXX agreed that XXXXX could retain$ of$ per month as
compensation for administration of the program. Her debts were approximately $

In these cases, the fair share revenues helped subsidize the monthly service charges of
$17 or $18 per month paid on the XXXXxX contracts.

Leased Employees

XXXXX regularly engaged 3-5 leased employees who performed consultations for
XXXXX (hereinafter referred to as employees). In XXXXX and XXXXX, XXXXX

15

Form 886-A

Exhibit I

engaged the services of XXXXX, XXXXX, XXXXX, XXXXX, XXXXX, XXXKXK, KXKXX,
XXXXX, and XXXXX. XXXXX, XXXXX, and XXXXX continue a working relationship
with XXXXX as leased employees

Some employees have social service backgrounds. Most consultants stated that they
did not have prior experience or training in the field of credit counseling prior to their
employment with XXXXX or XXXXX. Advertisements for consultants indicate that good
candidates have problem solving and communication skills and desire to help people in
financial crisis as follows:

Noted to run Sunday, XXXXx:
— XXXXX, (XXXXX)

. Fax XXXXX.

Employees were required to pass The Institute For Personal Finance counselor
certification exam within eighteen months of hiring date as a consultant. Passage is
now required within twelve months of commencing employment.

XXXXX's employees were trained to establish a clear purpose or motive for each
consultation session, gather financial information and identify the problem, offer

solutions for the client's review, develop a detailed plan for implementation of a solution
to resolve their financial problem, and confirm that the solution fits the purpose. (

) Possible solutions include a self -administered plan, debt management program,
personalized pian, and bankruptcy. ( ) Consultant development compact
disks (CDs) provide taped telephone calls with examples of questioning by the
consultants. Some callers were interested in Debt Management Plans (DMPs) solely
for reduced interest rates and payments, but the counselors were instructed to fully
develop their financial situation and determine the best solution. They were told that
creditors would not accept DMPs from individuals who have adequate cash flow and
only want to reduce their interest rates, credit card fees, and payment amounts. The
discussion leader stated on one call on a CD “We do not want to be signing up clients
that do not qualify. Our fair share is based on people that qualify. This (DMP) is not a
solution.” Creditors determine DMP clients. Consultants were trained to put an
emphasis on evaluation function, to find the root of the problem and find an effective
(agreeable to the credit card companies/payers of fair share) solution. On another he
Stated “Putting the solution ahead of the problem invalidates the session.”

The XXXXxX training manual contains instructions for employees on its counseling
model and a flow chart for counseling procedure. ( ) The Manual contains
instructions geared to enrolling individuals in DMPs, including assembling DMP packets
and Client Action Plan with necessary educational information. Additional instructions

16

Form 886-A

Exhibit I
State to provide non-DMP clients with specific educational information and referrals as is
pertinent to the client's situation and include a step-by-step accounting of the solution in
the Client Action Pian to be sent to the client. Consultants are also instructed to update
lead tracking for follow-up. Consultants update lead tracking upon receipt of a
completed DMP client information packet. Once a complete DMP client information
packet is received, the contacts the client, confirms their plans, and transitions the client
to Account Management personnel with XXXXX

Included in the Manual is “Counselor” position description ( ~ ), “Counselor Call
Evaluation Process ( ),” “Counseling Procedure ( ),” and
“Counseling Performance & Compensation ( )." “Counselor” position

description requires a consultants to attain at least level two (of four) consulting skills
consistently within the first six months of employment. In addition, it requires a
“minimum of 30 new (DMP) clients enrolled per month.” Current “Counseling
Performance & Compensation” document requires a minimum of 100 Client Action
Plans (CAPs) per month from leads, and every CAP must be presented to the client
with contact information including e-mail, address, and telephone numbers. This

ensures that all clients receive a documented overview of their situation with an action
plan. ,

Employees were evaluated based upon consultation call evaluations, leads handled,
availability to clients, schedule coverage, and retention of DMP clients. Employees
were compensated based upon points awarded for the performance categories.
Compensation may be adjusted up or down after three out of four consecutive ratings

are achieved. Employees were required to enroll a minimum number of DMP accounts
to keep their jobs.

E-mails from the Director of Counseling reflect revisions to “Counseling Performance &
Compensation” documents and a continuing concern about the productivity of XXXXX
employees and methods to measure quantity over quality of counseling sessions.
Personnel Action Notices indicated warnings for failure to reach the minimum standard
for clients signed onto DMPs for a month (30).

Consultation performance was measured and evaluated in five categories: “Counseling
Call evaluation ratings 40%; Leads handled 20%; Availability to counsel the client 20%;
Schedule coverage 10%; and Client retention 10%.” (

Performance and compensation tabulations take the points given from the above
categories. According to The “Counseling Performance” document ( )
points awarded for the performance categories could result in advancement in
compensation level. However, in order to advance from level to level the minimum
number of signs (DMPs) must be achieved for that increased level.

The “Counseling Performance” document ( ) provided the following
compensation structure to employees:

$45,000 level requires a minimum average of 45 signs per month

Form 886-A

Exhibit I

$38,000 level requires a minimum average of 38 signs per month
$30,000 level requires a minimum average of 30 signs per month

Example 2 states that if a consultant’s score in the five categories was qualified for
$38,000 a year and the counselor was at the $30,000 level and had an average number
of 39 signs, they would advance to the compensation level of $38,000. Example 1
Stated that if a consultant's score in the five categories was qualified for $38,000 a year
and the consultant was at the $30,000 level and had an average number of 36 signs,
they would remain at the $30,000 compensation level.

Compensation of consultants was geared toward increasing sales of DMPs. Some
employees were eligible for overtime, but there were no bonuses or incentives offered.

LAW

Section 501(a) of the Internal Revenue Code provides that an organization described in
section 501(c)(3) is exempt from income tax. 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 the net earnings inure to the
benefit of any private shareholder or individual. The term charitable includes relief of
the poor and distressed. Section 1 -501(c) (3)-1(d) (2), Income Tax Regulations.

The term educational includes (a) instruction or training of the individual for the purpose
of improving or developing his capabilities and (b) instruction of the public on subjects
useful to the individual and beneficial to the community. Treas. Reg. § 1.501(c)(3)-
1(d)(3). In other words, the two components of education are public education and
individual training.

Section 1.501(c)(3)-1(a)(1) of the 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.

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. The existence of a
Substantial nonexempt Purpose, regardless of the number or importance of exempt
purposes, will cause failure of the operational test. Better Business Bureau of
Washington, D.C. v. U.S., 326 U.S. 279 (1945).

Educational purposes include instruction or training of the individual for the purpose of

improving or developing his capabilities and instruction of the public on useful and
beneficial Subjects. Treas. Reg. § 1.501(c)(3)-1(d)(3)._ In Better Business Bureau of

18

Form 886-A

. . Exhibit I
Washington D.C., Inc. v. United States, 326 U.S. 279 (1945), the Supreme Court held
that the presence of a single non-exempt purpose, if substantial in nature, will destroy
the exemption regardless of the number or importance of truly exempt purposes. The
Court found that the trade association had an “underlying commercial motive” that
distinguished its educational program from that carried out by a university.

In American Institute for Economic Research v. United States, 302 F. 2d 934 (Ct. Cl.
1962), the Court considered the status of an organization that provided analyses of
securities and industries and of the economic climate in general. The organization sold
subscriptions to various periodicals and services providing advice for purchases of
individual securities. Although the court noted that education is a broad concept, and
assumed for the sake of argument that the organization had an educational purpose, it
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.

An organization must establish that it serves a public rather than a private interest and
“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.” Treas. Reg. §
1.501(c)(3)-1(d)(1){ii). Prohibited private interests include those of unrelated third
parties as well as insiders. Christian Stewardship Assistance, Inc. v. Commissioner, 70
T.C. 1037 (1978); American Campaign Academy v. Commissioner, 92 T.C. 1053
(1989). Private benefits include an “advantage; profit; fruit; privilege; gain; [or] interest.”
Retired Teachers Legal Fund v. Commissioner, 78 T.C. 280, 286 (1982).

An organization formed to educate people in Hawaii in the theory and practice of “est”
was determined by the Tax Court to a part of a “franchise system which is operated for
private benefit,” and, therefore, should not be recognized as exempt under section
501(c)(3) of the Code. est of Hawaii v. Commissioner, 71 T.C. 1067, 1080 (1979).
Although the organization was not formally controlled by the same individuals who
controlled the for-profit entity that owned the license to the “est” body of knowledge,
publications, and methods, the for-profit entity exerted considerable control over the
applicant's activities by setting pricing, the number and frequency of different kinds of
seminars and training, and providing the trainers and management personnel who are
responsible to it in addition to setting price for the training. The court stated that the fact
that the organization’s rights were dependent upon its tax-exempt status showed the
likelihood that the for-profit entities were trading on that status. The question for the
court was not whether the payments made to the for-profit were excessive, but whether
the for-profit entity benefited substantially from the operation of the organization. The
court determined that there was a substantial private benefit because the organization
“was simply the instrument to subsidize the for-profit corporations and not vice versa
and had no life independent of those corporations.”

The Service has issued two rulings holding credit counseling organizations to be tax
exempt. Rev. Rul. 65-299, 1965-2 C.B. 165, granted exemption to a 501(c)(4)

Form 886-A

Exhibit I

organization whose purpose was to assist families and individuals with financial

' problems and to help reduce the incidence of personal bankruptcy. Its primary activity
appears to have been meeting with people in financial difficulties to “analyze the specific
problems involved and counsel on the payment of their debts.” The organization also
advised applicants on proration and payment of debts, negotiated with creditors and set
up debt repayment plans. It did not restrict its services to the needy. It made no charge
for the counseling services, indicating they were separate from the debt repayment
arrangements. It made “a nominal charge” for monthly prorating services to cover
postage and supplies. For financial support, it relied upon voluntary contributions from
local businesses, lending agencies, and labor unions.

Rev. Rul. 69-441, 1969-2 C.B. 115, granted 501(c)(3) status to an organization with two
functions: it educated the public on personal money management, using films,
speakers, and publications, and provided individual counseling to “low-income
individuals and families.” As part of its counseling, it established budget plans, i.e., debt
management plans, for some of its clients. The debt management services were
provided without charge. The organization was supported by contributions primarily
from creditors. By virtue of aiding exclusively low income people, without charge, as
well as providing education to the public, the organization qualified for section 501(c)(3)
status.

In the case of Consumer Credit Counseling Service of Alabama, Inc. v. U.S., 44
A.F.T.R.2d 78-5052 (D.D.C. 1978), the District Court for the District of Columbia held
that a credit counseling organization qualified as charitable and educational under
section 501(c)(3). It fulfilled charitable purposes by educating the public on subjects
useful to the individual and beneficial to the community. Treas. Reg.

§ 1.501(c)(3)-1(d)(3)(i)(b). For this, it charged no fee. The court found that the
counseling programs were also educational and charitable; the debt management and
creditor intercession activities were “an integral part” of the agencies’ counseling
function and thus were charitable and educational. Even if this were not the case, the
court viewed the debt management and creditor intercession activities as incidental to
the agencies’ principal functions, as only approximately 12 percent of the counselors’
time was applied to debt management programs and the charge for the service was
“nominal.” The court also considered the facts that the agency was publicly supported
and that it had a board dominated by members of the general public as factors
indicating a charitable operation. See also, Credit Counseling Centers of Oklahoma,
Inc. v. United States, 79-2 U.S.T.C. 9468 (D.D.C. 1979), in which the facts and legal
analysis were virtually. identical to those in Consumer Credit Counseling Centers of
Alabama, Inc. v. United States, discussed immediately above.

The organizations included in the above decision waived the monthly fees when the
payments would work a financial hardship. The professional counselors employed by
the organizations spent about 88 percent of their time in activities such as information
dissemination and counseling assistance rather than those connected with the debt
management programs. The primary sources of revenue for these organizations were

Form 886-A

Exhibit I

provided by government and private foundation grants, contributions, and assistance
from labor agencies and United Way.

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. Rul. 72-369, 1972-2 C.B. 245, held that an organization formed to provide
managerial and consulting services at cost to unrelated exempt organizations did not
qualify for exemption under section 501(c)(3) of the Code. Providing managerial and
consulting services on a regular basis for a fee is a trade or business ordinarily carried
on for profit. The fact that the services were provided at cost and solely for exempt
organizations was not sufficient to characterize the activity as charitable for purposes of
section 501(c)(3) of the Code. “Furnishing the services at cost lacks the donative
element necessary to establish this activity as charitable.”

In B.S.W. Group, Inc. v. Commissioner, 70 T.C. 352 (1978), the court found that a

corporation formed to provide consulting services was not exempt under section
501(c)(3) because its activities constituted the conduct of a trade or business that is
ordinarily carried on by commercial ventures organized for profit. Its primary purpose
was not charitable, educational, nor scientific, but rather commercial. The court found
that the corporation had completely failed to demonstrate that its services were not in
competition with commercial businesses. The court found that the organization’s
financing did not resemble that of the typical 501(c)(3) organization. It had not solicited,
nor had it received, voluntary contributions from the public. Its only source of income
was generated from services, and those fees were set high enough to recoup all
projected costs, and to produce a profit. And finally, the corporation had failed to limit
its clientele to organizations that were section 501(c)(3) exempt organizations.

In Easter House v. United States, 846 F. 2d 78 (Fed. Cir. 1988), affg 12 CI.Ct. 476
(1987), the court found an organization that operated an adoption agency was not
exempt under section 501(c)(3) of the Code because a substantial purpose of the
adoption activity was a non-exempt commercial purpose. It found that the adoption
services did not further the exempt purposes of providing educational and charitable
Services to the unwed mothers and children. Rather, the services for unwed mothers
and children were merely provided “incident” to the organization's adoption service
business.

21

Form 886-A

Exhibit I

Internal Revenue Code section 501(c)(3) specifies that an exempt organization
described therein is one in which “no part of the net of earnings inures to the benefit of
any private shareholder or individual.” The words “private shareholder or individual” in
section 501 to refer to persons having a personal and private interest in the activities of
the organization. Treas. Reg. § 1.501(a)-1(c). The inurement prohibition provision ‘is
designed to prevent the siphoning of charitable receipts to insiders of the charity... .”
United Cancer Council v. Commissioner, 165 F.3d 1173 (7th Cir. 1999): Reasonable
compensation does not constitute inurement. Birmingham Business College v.
Commissioner, 276 F.2d 476, 480 (5th Cir. 1960).

In Church By Mail, Inc. v. Commissioner, T.C. Memo 1984-349, affd 765 F. 2d 1387 (9"
Cir. 1985) the tax court found that a church was operated with a substantial purpose of
providing a market for an advertising and mailing company owned by the same people
who controlled the church. The church argued that the contracts between the two were
reasonable, but the Court of Appeals pointed out that “the critical inquiry is not whether
particular contractual payments to a related for-profit organization are reasonable or
excessive, but instead whether the entire enterprise is carried on in such a manner that
the for-profit organization benefits substantially from the operation of the Church.

In International Postgraduate Medical Foundation v. Commissioner, T.C. Memo 1989-
36, the court found an organization that ran tours aimed at doctors and their families
was operated to benefit the private interests of both an individual who controlled the
organization and a for-profit travel agency (H&C Tours) that handled all of its tour
arrangements. The organization used the H&C Tours exclusively for all travel
arrangements. There was no evidence that the organization solicited competitive bids
from any travel agency for travel arrangements for its tours other than H&C Tours. The
organization physically located its office within the offices of H&C Tours, which provided
it secretarial, clerical, and aXXXXXnistrative personnel for a fee equal to H&C Tours’
costs. The organization spent 90 percent of its revenue on travel brochures prepared to
solicit customers for tours arranged by the travel agency. The brochures emphasized
the sightseeing and recreational component of the tours, but did not describe the
medical curriculum for the seminars and symposia that was the basis for exemption.
Educational activities occurred on less than one-half of the days on a typical tour.

The court found that a substantial purpose of the organization's operations was to
increase the income of H&C Tours. The president of H&C Tours controlled the
organization and exercised that control for the benefit of H&C Tours and himself.
Moreover, the aXXXXXnistrative record supported the finding that the organization was
formed to obtain customers for H&C Tours.

The court in Redlands Surgical Services v. Commissioner, 113 T.C. 47 (1999) stated
that merely entering a partnership with private parties in which they receive a return on
a capital investment does not impermissibly confer private benefit. However, a detailed
examination of the Redlands surgery center venture convinced the court that the
petitioner had ceded control to private parties having an independent economic interest
in the activity and no obligation to promote charitable purposes ahead of profit making.
Therefore, the applicant was not operated exclusively for exempt purposes. The Court

22

Form 886-A

; | Exhibit I
pointed to the long-term management contract with a party related to the for-profit, with
broad discretion, and a fee based upon gross revenue. Furthermore, the record did not
show that the nonprofit had any role in negotiating the contract.

In Aid to Artisans v. Commissioner, 71 T.C. 202 (1978) all profits are earmarked for
specific charitable purposes; Incorporated Trustees of the Gospel Worker Society, 510
F. Supp. 374 (D.D.C. 1981), affd without op. 672 F.2d 894 (D.C. Cir. 1981) The courts
point that accumulation of large amounts of money, or payments of large amounts to
insiders and outsiders, without using the money to further charitable goals is evidence
of a non-exempt purpose.

The Credit Repair Organizations Act (CROA), 15 U.S.C. § 1679 et seq., effective April
1, 1997, imposes restrictions on credit repair organizations, including forbidding the
making of untrue or misleading statements and forbidding advance payment, before
services are fully performed. 15 U.S.C. § 1679b. Significantly, section 501(c)(3)
organizations are excluded from regulation under the CROA.

The CROA defines a credit repair organization as:

any person who uses any instrumentality of interstate commerce or the mails to sell,
provide, or perform (or represent that such person can or will sell, provide, or perform)
any service, in return for the payment of money or other valuable consideration, for the
express or implied purpose of—

(i) improving any consumer's credit record, credit history, or credit rating, or

(ii) providing advice or assistance to any consumer with regard to any activity or
service described in clause (i).

15 U.S.C. § 1679a(3). The courts have interpreted this definition broadly to apply to
credit counseling agencies. The Federal Trade Commission's policy is that if an entity
communicates with consumers in any way about the consumers’ credit situation, it is
providing a service covered by the CROA. In Re: National Credit Management Group,
LLC, 21 F. Supp. 2d 424, 458 (N.D.N.J. 1998).

EXEMPT ORGANIZATION’S POSITION

The exempt organization considers itself “the white hats” of the industry. XXXXX insists
that its activities are in furtherance of a counseling and debt repayment program that
restore financial balance to peoples’ lives and further purposes described in section
501(c)(3) of the Internal Revenue Code.

However, organization has now merged with the XXXXX non-profit corporation XXXXX

and considers itself terminated as of XXXXX. The organization had net liabilities at the
end of the years under examination December 31, XXXXX and when it merged with the

parent corporation XXXXX as of December 31, and terminated,

23

Form 886-A

Exhibit I
Revenue Agent sees an alternative position of termination as of December 31,

GOVERNMENT POSITION

XXXXX is not operated exclusively for exempt purposes described within Internal
Revenue Code section 501(c)(3) and its tax-exempt status of XXXXX should be
revoked for failure to operate exclusively for 501(c)(3) purposes and for violating the
prohibition on inurement as set forth in Internal Revenue Code section 501(c)(3).

XXXXX was not operated with public Support and public control. It was controlled by
XXXXX and XXXXX, principals of XXXXX and XXXXX, Inc. dba XXXXX. It was
privately supported in aggregate by credit card companies with over 50 percent of its
income in the form of fair share from credit card companies.

XXXXX is not engaged primarily in activities that accomplish an exempt purpose. It did
not exclusively serve a charitable class such as low-income individuals. It did waive
fees and provide some services free or below cost if a DMP was desirable to creditors.
Organization operations have an inherently commercial nature and it provides services
to any caller accepted by the creditors. If a caller has ability to pay, then services are
provided at market rates allowed within the State of residence. It operated to serve a
substantial non-exempt purpose.

The purpose of XXXXX's activities differs substantially from those of the organizations
in Rev. Rul. 65-299, Rev. Rul. 69-441, and Consumer Credit Counseling Service of
Alabama, Inc. v. U.S. In this case, XXXXX engages in minimal activities which further
an exempt purpose. Its “counseling” activity is nothing more than an interviewing
activity; XXXXX screens consumers to market and sell DMP services. There is very
little education provided to consumers who contact, or are contacted by XXXXX from
lead tracking. Employees were evaluated not on the ability to provide good education
or counseling services to clients, but on their ability to identify the appropriate solution
for their problem through mass screening. The evaluation of employees encouraged
interviewing potential DMP candidates, producing the required 100 monthly or 300
quarterly client action plans, and Signing and retaining 30 new DMP clients each month.
Counselor compensation rewarded enrollments of consumers in DMPs and did not
encourage any meaningful education or credit counseling to take place. The training
manual reinforces this work environment by setting production goals for employees to
Produce 100 CAPs and enroll 30 new DMP clients per month. Unlike the credit .
counseling organizations described in the Revenue Rulings referred to above, and in
Consumer Credit Counseling Service of Alabama, Inc. v. U.S., XXXXX provides very —
little counseling or education to its clients. .

XXXXX did not engage in substantial educational outreach activity to community
groups. The organization did not have the appropriate human resources for mass
educational programs in XXXXX in XXXXX and XXXXX. XXXXX did not

24

Form 886-A

Exhibit I

have an educational budget or a coordinated educational workshop or seminar
program. Presentations made on dealing with debt crisis and fundamentals of
budgeting and credit were not supported by any agendas or other record of curriculum.
The presentations about financial crisis for homeowners could also promote DMP —
services. There is no evidence that the group presentations did anything other than
market the DMP product. In this case, we saw receipts of such magnitude paid out to
for-profit organizations but very little going to further public purposes. In this context,
the credit counseling organization budgeted no money for public educational activities,
apart from advertising, and promoted non-exempt purposes. There is every indication
that its activities were directed and its income was being used primarily for non-exempt
purposes.

The reason XXXXX and the other exempt organizations which are part of the XXXXX
enterprise are organized as exempt organizations is to avoid the regulatory scheme of
the Credit Repair Organizations Act (CROA), 15 U.S.C. section 1679,et.seq. CROA
was enacted to protect consumers by banning certain deceptive practices in the credit
counseling industry. If XXXXX was a for-profit company, the CROA would prohibit it
from charging fees in advance of fully providing services. Because section 501(c)(3)
organizations are exempted from the provisions of CROA, XXXXX is able to engage in
deceptive business practices that Congress intended to prohibit when it passed the
CROA law. As such, XXXXX is operated for a substantial non-exempt purpose, that of
carrying on a business while avoiding federal regulation. In addition, XXXXX could not
collect “fair share” payments from creditors if it did not have exempt status. The entire
DMP business depended on an organization having tax-exempt status.

XXXXX was operated for the purpose of serving a private benefit rather than public
interests. The “common enterprise” of XXXXX, XXXXX dba XXXXX, and other exempt
organizations which had fulfillment agreements with XXXXX, Inc. dba XXXXX was
formed for the private benefit of XXXXX and first XXXXX (who sold his interests to
XXXXX and agreed to not compete) and later XXXXX as highly compensated Chief
Operating Officer. Once the client was enrolled in a DMP, all of the processing of that
client's DMP was turned over to XXXXX dba XXXXX. XXXXX provided a steady stream
of business to XXXXX, and XXXXX had complete control over the enrolled DMPs.
XXXXX collected debtor payments, including processing fees, and disbursed payments
to creditors. XXXXX dictated the per client charges regardless of the exempt
organization's ability to pay. XXXXX did not solicit any companies other than XXXXX
to process its DMPs even though it operated with annual losses. XXXXX has a
substantial non-exempt purpose of signing up clients for DMPs to provide business to

XXXXX dba XXXXX.

More than an insubstantial part of XXXXx’s activities are in furtherance of a non-exempt
Purpose. It was also operated in competition with commercial businesses using
advertising, pricing, and business methods.

XXXXX has a substantial non-exempt purpose of signing up clients for DMPs to provide
revenue collection services for credit card companies and other unsecured creditors.
XXXXxX is not furthering any charitable or educational purpose when it interviews

25

Form 886-A

Exhibit I

consumers or screens DMP candidates to find DMPs acceptable to the creditors. To
receive fair share payments, the organization fit into a system created to serve the
creditors. If a client's credit score was too high, then the DMP would be rejected by
creditors because organization would compete with the creditors for income on
collectible accounts. XXXXX was operated in competition with commercial businesses.
It advertised and obtained leads to increase its revenues and evaluated employees on
their production similar to business methods of evaluation. Its employees were
compensated based on the amount of DMP business they brought in and retained, and
were threatened with being fired for insufficient DMP business. They were trained to
"select DMP consumers that they could retain to increase the organization's fair share
revenues.

The activities were not directed to benefit the public, but rather private interests of
XXXXX dba XXXXX and credit card companies.

The net earnings of XXXXxX inured to the benefit of XXXXX and XXXXX in the form of
executive compensation paid through service bureau fees and added market value in
XXXXX's stock in XXXXX sold to XXXXX.

CONCLUSION

In summary, XXXXX was not operated exclusively for exempt purposes, because it did
not engage primarily in activities that accomplish an exempt purpose. More than an
insubstantial part of XXXXX’s activities are in furtherance of a non-exempt purpose.

was operated for the purpose of serving a private benefit rather than public
interests, and a part of the net earnings of XXXXX inured to the benefit of XXXXX and
XXXXX, private individuals who are Officers of the corporation.

Accordingly, it is determined that XXXXxX is not an organization described in section

501(c)(3), and is not exempt from income tax under section 501(c)(3), effective XXXXxX,
XXXXX the beginning of the years under examination. .

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