IRS declines retroactive relief after debt-management fees and undisclosed related trustee

Plain-English summary

A nonprofit organization represented that it would provide free credit counseling, budgeting help, and debt-management assistance to financially distressed people. The IRS examination found that the organization primarily sold and managed debt-management plans, derived all of its income from those activities, and did not document the promised counseling or education. The examination also found that the organization omitted a related trustee and president from its exemption application and treated service fees as voluntary contributions. The IRS declined to limit the retroactive effect of revocation under IRC section 7805(b), concluding that the organization's operations materially differed from its representations.

Ruling snapshot

• Question: Should the IRS limit the retroactive effect of revoking the organization's section 501(c)(3) exemption?
• Outcome: Advice given, relief declined.
• Key authorities: IRC §§ 501(c)(3) and 7805(b); Treas. Reg. §§ 1.501(a)-1(a)(2) and 301.7805-1(b)

Full text (IRS public release)

INTERNAL REVENUE SERVICE

Release Number: 201407016 TE/GE TECHNICAL ADVICE MEMORANDUM
Release Date: 2/14/2014

Area Director, Area 4 TEGE Appeals
Philadelphia, PA NOV 22 2013

Taxpayer's Name: ###«## UIL Code: 501.03-30

Taxpayer's Address: REEKKERKKE

REEKEKKEKEK

Taxpayer's ID No.: RKKKKKKKKK
Year(s) Involved: ****

Conference Held: *#

LEGEND:
Taxpayer = RRKRAKEEEK
ISSUE:

Whether the Commissioner, TE/GE, should exercise discretion to grant Taxpayer relief
under § 7805(b) to limit the retroactive effect of revocation of its exempt status under
§ 501(c)(3).

FACTS:

Application for Exemption

The Taxpayer, a non-profit corporation, was recognized as exempt under § 501(c)(3).
Its Articles of Incorporation provided that Taxpayer was organized for the following
purposes:

e To provide family credit counseling services for members of the public and to
advise persons seeking credit, budget, or financial advice;

e To seek the cooperation of merchants, lending institutions, banks, and others—
individually and through their associations, public officials, and offices;

e To promote budgeting, thrift, and the protection of individuals and families
emphasizing consumer credit;

e To conduct research projects, advertising, public relation activities and other
activities with respect to budgeting, financial matters, and consumer credit;

To engage in educational pursuits that assists individuals or families in life
management skills.

Taxpayer stated it would engage in the following activities:

(1) Giving charitable advice to poor, underprivileged, and financially
distressed members of the community to help the poor and their
families get out of debt and stay out of debt.

(2) Doing charitable work for the poor, underprivileged, and
financially distressed members of the community by contacting their
creditors for them, rescheduling their payments, helping them
complete forms or completing forms for them, and writing letters for
them to help them get out of, reduce, and stay out of debt.

(3) Lessening the burdens of state and federal government by
helping poor, underprivileged or financially distressed members of
the community from having to seek and rely upon state or federal
financial aid in order to feed, house, or support themselves or their
families.

(4) Educating the poor, underprivileged, or financially distressed
members of the community on how to set up and live within budgets
that they can afford so as to avoid getting into debt and behind in
their payments to their creditors.

(5) Lessening neighborhood tensions by _ helping poor,
underprivileged, and financially distressed members of the
community from having to [declare] bankruptcy, become homeless,
and resorting to possible criminal activities to take money to survive.
(6) Combating community deterioration and juvenile delinquency by

helping parents get out of debt and stay out of debt, support —

themselves through their own labor and provide safer, more secure
homes for their children.

Taxpayer further stated that all activities would be initiated by members of the
community who contacted Taxpayer for assistance and would be conducted at its office.
Taxpayer stated it would meet people face-to-face, gather an individual’s or family’s
credit card statements, and analyze their income and expenses. Moreover, based on
the criteria of each of their creditors, Taxpayer would help them establish a budget and
manage their debt by making a single monthly payment to the creditors through
Taxpayer. When Taxpayer would receive those payments, it would then distribute the
payment among the creditors. Taxpayer stated that credit counseling services would be
available to anyone who wished to participate in the program.

Taxpayer indicated that its sole source of income would be gifts, grants, and
contributions. It also stated that 50 percent of its financial support would come from
contributions from the general public and 50 percent from private organizations.
Taxpayer stated that its consultation, analysis, and budget planning would be free to the
community. If persons or families further wished to use Taxpayer's services, upon

enrollment in the debt management program, they would be advised to make a
voluntary contribution to Taxpayer. Persons who enrolled and continued to use
Taxpayer's services would be advised to make a voluntary contribution for every

‘ monthly payment they made through Taxpayer. Moreover, Taxpayer answered in the
negative to the question: If the organization provides benefits, services, or products, are
the recipients required, or will they be required, to pay for them?

Taxpayer listed three members on its governing body, two of whom were husband and
wife. Taxpayer stated that the husband and wife trustees would conduct all Taxpayer's
activities.

Based upon these representations, the Service issued a favorable determination letter
to Taxpayer.

Examination

The examination concluded that Taxpayer did not provide any education or counseling
tailored to the needs of the individuals. The exam agent found that Taxpayer did not
document any referrals to professional outside help, or keep any records of client
education or counseling. Taxpayer's only educational materials appeared on its website
after April of the first exam year, and were limited to budgeting tools, links to outside
resources, and information on DMPs. The only files Taxpayer kept were those of DMP
clients, containing DMP contracts and credit card statements. However, Taxpayer
failed to keep files in which it provides education to clients. Taxpayer stated that the
reason it keeps only files on DMP-enrolled clients is that it would be too costly to keep
files on everyone who called. The Taxpayer maintained that it conducted face-to-face
counseling and seminars, but failed to provide documentation that it did so. The
examination found that Taxpayer's primary activities were selling and managing debt
management plan (DMP) accounts. It maintained between 800 and 850 DMPs at any
given time, with 100 percent of its income derived from selling and managing the DMPs.
Its website generates DMP leads. Thus, Taxpayer did not conduct its activities
exclusively in a manner that furthers a tax-exempt purpose.

The examination also found that a fourth trustee was on the board of directors;
however, Taxpayer did not list him in the Form 1023 application. The trustee was also
related through a familial relationship. The fourth trustee was Taxpayer's president who
stated he had not listed himself as an officer on the Form 1023 because he planned to
receive a full-time salary and believed that paid officers would be looked upon
unfavorably. President was in charge of daily operations, performed all substantive
work, and hired minimal clerical help. President was the only credit counselor but had
no certifications or degrees in credit counseling, counseling, or social work, although
Taxpayer's website and telephone answering service asked prospective clients to
“speak with [Taxpayer's] certified counselors .. . .”" President stated that he acquired
general knowledge about credit counseling and DMPs from a friend. President created
Taxpayer's website and wrote all the information contained on the website.

The examination concluded that Taxpayer's primary activity of enrolling and managing
the debt accounts of clients in DMPs generated all of Taxpayer's income. Taxpayer
distributed a client's DMP payment minus a “voluntary” contribution to each creditor
under the terms of the DMP. During the examination period, Taxpayer did not receive
any public or private contributions. Taxpayer's revenue was derived from either its DMP
clients or from the banks to which it provided DMP payments (fair share payments).
Taxpayer was unable to furnish any documentation that DMP fees charged to clients
were voluntary, and was also unable to provide any documentation that Taxpayer
waived any of the fees.

Taxpayer appealed the proposed revocation. Appeals sustained the revocation.
Following the appeals process, the National Office received this request for relief from
retroactive revocation as a mandatory TAM.

LEGAL STANDARD:

Section 7805(b)(8) provides that the Secretary may prescribe the extent, if any, to which
any ruling (including any judicial decision or any administrative determination other than
by regulation) relating to the internal revenue laws shall be applied without retroactive
effect.

Section 1.501(a)-1(a)(2) of the Income Tax Regulations states that an organization that
the Commissioner determined to be exempt under § 501(a) may rely upon such
determination so long as there are no substantial changes in the organization’s
character, purposes, or methods of operation, and subject to the Commissioner's
inherent power to revoke rulings because of a change in the law or regulations, or for
other good cause.

Section 301.7805-1(b) of the Procedure and Administration Regulations grants the
Commissioner authority to prescribe the extent to which any ruling issued by his
authorization shall be applied without retroactive effect.

Section 4.04 of Rev. Proc. 2013-5, 2013-1 I.R.B. 170, states that all requests for relief
under § 7805(b) must be made through a request for technical advice (TAM). Section
19.04 states further that when, during the course of an examination by EO
Examinations or consideration by the Appeals Area Director, a taxpayer is informed of a
proposed revocation, a request to limit the retroactive application of the revocation must
itself be made in the form of a TAM and should discuss the items listed in § 18.06 of
Rev. Proc. 2013-5, as they relate to the taxpayer's situation.

Section 18 of Rev. Proc. 2013-5 lists the criteria necessary for granting § 7805(b) relief
as well as the effect of such relief. Section 18.06 states, in part, that a TAM that
revokes a determination letter is not applied retroactively if:

(1) there has been no misstatement or omission of material facts;

(2) the facts at the time of the transaction are not materially different from the facts
on which the determination letter was based;

(3) there has been no change in the applicable law; and

(4) the taxpayer directly involved in the determination letter acted in good faith in
relying on the determination letter, and the retroactive revocation would be to the
taxpayer’s detriment.

Rev. Proc. 2013-9, 2013-2 I.R.B. 255, sets forth procedures for issuing determination
letters (from EO Determinations) and rulings (on applications for recognition of exempt
status by EO Technical) on the exempt status of organizations under § 501. These
procedures also apply to revocation or modification of determination letters or rulings.

Section 12.01 of Rev. Proc. 2013-9 states, in part, that the revocation or modification of
a determination letter or ruling recognizing exemption may be retroactive if the
organization omitted or misstated a material fact, or operated in a manner materially
different from that originally represented. In certain cases an organization may seek
relief from retroactive revocation or modification of a determination or ruling under

§ 7805(b) of the Code using the procedures set forth in Rev. Proc. 2013-4, 2013-1
I.R.B. 126, which further refers to Rev. Proc. 2013-5, §§ 18 and 19.

Section 12.01(1) of Rev. Proc. 2013-9 states that where there is a material change
inconsistent with exemption in the character, the purpose, or the method of operation of
an organization, revocation or modification will ordinarily take effect as of the date of
such material change.

In Automobile Club of Michigan v. Commissioner, 353 U.S. 180, 184 (1957), the
Supreme Court held that the Commissioner has broad discretion to revoke a ruling
retroactively. It further held that a retroactive ruling “may not be disturbed unless . . . the
Commissioner abused the discretion vested in him...” Id.

In Stevens Bros. Foundation, Inc. v. Commissioner, 324 F.2d 633, 641 (1963), the court
found the Foundation’s efforts “far from convincing” to demonstrate that its information
reports were adequate and sufficient to apprise the Commissioner of its entry into the
business activities which led to denial of its tax-exempt status. Shortly after receiving its
tax-exempt ruling, the Foundation contracted with a for-profit company, but failed to
disclose this fact to the Commissioner on its Forms 990. The court upheld the Service's
retroactive revocation.

In Variety Club Tent No. 6 Charities, Inc. v. Commissioner, 74 T.C.M. (CCH) 1485

(1997), the court held that petitioner “operated in a manner materially different from that
originally represented.” The organization represented in its exemption application and
articles of incorporation that no part of its net income would inure to the benefit of any
private shareholder or individual. But the court found instances of inurement over
several years, and upheld the Service's retroactive revocation for such years.

ANALYSIS:

During the years under exam, Taxpayer's operations were materially different from the
description it provided in its exemption application. See Variety Club Tent No. 6
Charities, 74 T.C.M. at 1485; Rev. Proc. 2013-9 at § 12.01. Taxpayer claimed on its
Form 1023 that it would educate the poor, underprivileged, or financially distressed
members of the community on budgeting, consumer finance, and credit, as well as
promote such education. The examination found that Taxpayer devoted nearly all of its
time and resources to selling and servicing DMP accounts. Thus, Taxpayer did not
conduct its activities exclusively in a manner that furthers a tax-exempt purpose.
Taxpayer also claimed on its Form 1023 that its income was from gifts, grants, and
contributions from the general public and private organizations. It further stated that, if
the consumer wanted to take advantage of a DMP, the consumer was advised to make
a voluntary contribution(s). However, the examination revealed that the charitable
contributions were actually fair share payments, and the payments the Taxpayer initially
characterized as voluntary contributions from individuals enrolled in DMPs were fees for
services. Taxpayer maintained in the Form 1023 that, if it provides benefits, services, or
products, the recipients would not be required to pay for them. However, Taxpayer was
unable to furnish any documentation that DMP fees charged to clients were voluntary.

It was also unable to provide any documentation that Taxpayer waived any of the fees.
Finally, Taxpayer admitted to the examination agent that it had purposefully omitted
from its Form 1023 application the existence of an additional, related trustee who also
served as president and as the only full-time employee. Taxpayer's president stated he
had not listed himself as an officer on the Form 1023 because he planned to receive a
full-time salary and believed that paid officers would be looked upon unfavorably. Thus,
Taxpayer did not fully apprise the Service of the material changes in its operations. See
Stevens Bros. Foundation, 324 F.2d at 641 (failure to adequately and sufficiently inform
the Service of material changes in operations).

Therefore, revocation may be retroactive to the first year under examination, when the
Service determined Taxpayer had made material changes in its operations. See
Automobile Club of Michigan, 353 U.S. at 184 (Commissioner has broad discretion to
revoke a ruling retroactively); Rev. Proc. 2013-9 at § 12.01(1) (revocation ordinarily
applies as of the date of material changes in operations.)

CONCLUSION:

The Commissioner, TEGE, has declined to exercise discretion to limit the retroactive
effect of revocation of exempt status under § 501(c)(3). Revocation shall be effective as
of the first day of the first tax year under exam.