The Internal Revenue Service issued a preliminary report yesterday highly critical of credit counseling agencies, saying it was moving to yank the tax-exempt status of dozens of firms and widening its probe in an effort to crack down on rampant abuse in the $1 billion-a-year industry.
The nonprofit credit counseling industry, which people in financial trouble turn to for help and advice, has become a big business "dominated by bad actors," IRS Commissioner Mark Everson said.
"These organizations have not been operating for the public good and don't deserve tax-exempt status," he said.
A two-year audit by the IRS of 63 mostly larger credit counseling firms found them "preying on people who are at their most vulnerable" by using high-pressure tactics to sell expensive "cookie-cutter" debt management plans without regard for the client's situation or ability to pay, Mr. Everson said in a conference call with reporters.
The report comes as more debt-ridden consumers are being steered to counseling services. As part of last year's bankruptcy reform act, debtors are now required to undergo counseling before they can file for bankruptcy.
The IRS has terminated or is in the process of terminating the tax-exempt status of 41 agencies. The other 22 are still under investigation. Some also could face criminal charges, Mr. Everson said.
He said the targeted firms offered little, if any, education or counseling, which should be the primary focus of a tax-exempt entity.
"What we were seeing is not a very balanced program of discussion, but a herding of people ... into a debt management plan designed to generate fees," he said.
Calling the industry the "poster child for bad conduct" among nonprofits, Mr. Everson also said some agencies funnel money to for-profit affiliates.
The agency is expanding its probe by taking the "extraordinary" step of sending compliance letters to the remaining 740 known tax-exempt credit counseling agencies, he said. The responses could trigger more audits, he said.
The IRS also has tightened its criteria for granting tax-exempt status. Of the roughly 100 applications filed by new credit counseling agencies since 2003, the IRS has approved just three, Mr. Everson said.
He called problems in the industry "unbelievably deep," but noted that there remained "many good organizations" that are "trying to do their best" offering counseling and education to help people get their finances back on track.
"They are not operating a commercial business for the benefit of officers and directors," he said.
The president of the trade association for the credit counseling industry -- the Association of Independent Consumer Credit Counseling Agencies -- did not return a phone call yesterday seeking comment.
Mr. Everson had little advice for consumers searching for a reputable credit counseling service, other than saying references were important and that picking an agency based on a call from a telemarketer was "not sensible."
Nonprofits and charities are exempt from the national Do Not Call list.
As part of the new bankruptcy law, the U.S. trustees office has devised a list of roughly 150 credit counseling agencies approved to counsel consumers prior to filing for bankruptcy. Mr. Everson wouldn't say if any of the agencies being audited by the IRS were on that list, but added that the IRS worked closely with the trustees office during its approval process.
He said the status of IRS audits was confidential, but that if a credit counseling agency's tax-exempt status were revoked, it would be made public.
The IRS' Web site lists a handful of credit counseling agencies whose nonprofit status was terminated within the last year, including the National Center for Debt Elimination in North Huntingdon. (To see the list, go to www.irs.gov, enter Pub 78 in the search box, click "Publication 78," then click "Recent Deletions.")
The president of the North Huntingdon firm, Dave Leuthold, said the company did not contest the IRS ruling and was not fined or penalized.
"We were glad they did it," he said, contending that the company got bad legal advice when the firm was set up as a nonprofit in 2000.
Patricia Sabatini can be reached at firstname.lastname@example.org or 412-263-3066.