photo © 2007 paul stumpr | more info (via: Wylio)Jim Buttonow, a CPA and former IRS Agent has released information about why the very premise of selling tax relief services for an advance fee is something consumers should be protected from.
Below you will find submitted comments to the Federal Trade Commission regarding the selling of tax relief services.
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My name is Jim Buttonow. I am a Certified Public Accountant and design tax software products for New River Innovation, a technology company based in Greensboro, NC. I want to respond and comment on whether the Telemarketing Sales Rule advanced-fee limitations should be applied to Tax Debt (TD) Settlement/Relief companies.
As I will discuss below in detail, my position is that the TSR advanced-fee limitations should apply and be enforced to tax debt settlement/relief companies. I take this position because the business model and operations of most tax debt companies do not protect the interests of the consumer. I believe that consumers need to be in control of the fees they pay to hold TD relief providers accountable for their services. My conclusions are based on the following facts:
- Deceptive practices in the tax debt relief industry are as, if not more, abusive than the debt settlement/relief industry.
- Fees are charged and paid (in full or in part) before the misrepresentation or lack of service is discovered by the consumer.
- The industry has demonstrated an unwillingness to regulate itself in a manner that would protect the consumer, as evidenced by its deceptive advertising methods and the business model adjustments being undertaken in attempt to circumvent the advanced-fee ban in the statute.
First, I want to provide some background for the context of this feedback. I have extensive experience in the credit counseling/debt settlement industry as a regulator and in the tax debt industry as a former director of a national company. My experience as a regulator was with the Internal Revenue Service, Tax Exempt Organizations (TE/GE) Division, from 1987 to 2006. From 2001 to 2006, I worked directly in examining the activities of credit counseling companies for compliance with the Internal Revenue Code, specifically section 501(c)(3) and its related statutes. The IRS examinations in this industry focused heavily on deceptive practices of these organizations. I had the opportunity to work with the FTC and various state attorneys general on industry issues.
I also have experience operating a tax resolution company. In 2006, I left the public sector and joined a national tax resolution company with the goal of providing automation and IRS expertise to solve consumer tax problems. Our goal was to differentiate ourselves ethically from many national tax debt relief companies by offering realistic services with honest advertising. We believed that this was the winning business model. We achieved high consumer ratings (in fact, we received the prestigious Better Business Bureau “Torch Award” for business ethics and practices), but at the expense of profitability. We quickly learned that the advertising costs associated with being the “ethical player” in the market could not be sustained. Because we would not advertise deceptively, we were at a competitive disadvantage as other companies within the industry were able to generate sales at much lower costs due to their deceptive, albeit compelling, messages. Ultimately, because we would not advertise unrealistic and deceptive claims, we closed our business in September 2009.
Full disclosure on my comments
To provide full disclosure, I want to give you my current interest in the tax debt relief industry. New River Innovation will be a competitor to tax debt relief companies. We are encoding best practices of tax practitioners into a software system, much like TurboTax® has done in the area of tax preparation and filing. Our company and its investors believe that customers can solve their own tax problems online or with their trusted tax preparer -. We will provide the software to enable the consumer and the inexperienced but capable tax preparer to solve most tax problems, without high fees. In short, we agree with the FTC and the IRS that most people should just call the IRS to solve their tax problem(s),as most do, or use their local, trusted provider. As I stated previously, our software will support both methods.
New River Innovation is not a tax debt relief company of any kind. Instead, New River will provide software that allows a taxpayer to solve a multitude of tax problems online, one of which is tax debt. We will not represent or have an agency relationship with an individual or business before the IRS because the product allows consumers to resolve their own tax problems, themselves, at a low cost. As TurboTax® is clear to consumers that it does not employ people to prepare taxes (the software does it, based on consumers’ inputs), New River will be clear that it does not represent taxpayers before the IRS.
The main reason that tax debt relief companies have resisted the TSR advanced-fee ban is that it is detrimental to their business model.
There are three main functions to a tax debt relief company:
- Marketing: mainly via pay-per-click advertising, TV and radio ads.
- Sales: a “commissioned” sales force made up of individuals who are neither tax experts nor tax professionals.
- Operations: customer service representatives who have access to tax preparers and licensed tax professionals who can represent taxpayers before the IRS.
The main problem with this typical national tax debt business model is that it requires large upfront expenditures to acquire clients. With an average cost of acquisition of about $800 to$1,200 per client for advertising and sales commissions and an average fee of about $2,000 to $5,000 charged to the client (not adjusted for an average 15% bad debt allowance), there is not much margin in the business. These large upfront fees cause the business model to unravel at the expense of the consumer.
With the need for more cash to fund new sales and marketing expenditures, more pressure is put on the “sales” force to sell people tax settlement services for which they do not qualify. In other cases, the consumer may, technically speaking, qualify for the settlement, but cannot afford to pay the negotiated settlement amount. This leaves people without any benefit from the thousands of dollars they paid for the service. Furthermore, as the shrinking margins squeeze operations budgets and clients’ problems lag long after their fees are paid, service suffers and customers are redirected to a more likely outcome—most often a payment plan with the IRS.
The business model—if it survives—inevitably results in a deceptive qualification (sale), followed by a “bait and switch” to the more likely outcome in the future. For most of the new (correct) outcomes, consumers find that they could have accomplished them on their own. Inevitably, the tax debt settlement company must adopt this pattern or go out of business. Unless they constantly feed new consumers paying upfront fees, they cannot sustain their business model in the short term. Ultimately, this model is not sustainable in the long term, either, as the inventory of past clients becomes more than the cash flow can sustain.
You can see examples of this business model in the public financial statements of TaxMasters, a Texas-based tax relief company. For the first nine months of 2010, TaxMasters had more than $32 million in revenue. It also reported more than $19 million in selling, general and administrative expenses, of which $11.8 million was exclusively for advertising. For the quarter ending Sept. 30, 2010, TaxMasters reported a financial loss of $661,506. For the first nine months of 2010, TaxMasters had a $2.2 million financial loss. These losses come after a year in which TaxMasters experienced growth to a $27 million revenue company with $3.5 million in net profits. It is unlikely that these losses can be recouped without significant upfront sales, as TaxMasters’ net accounts receivable are $16.6 million and its deferred revenue is $25.4 million. Clearly, TaxMasters has funded its accumulated losses to date of more than $12.1 million by collecting far in advance of services performed. Because it has collected so far in advance and has accumulated a client base that needs continual service, TaxMasters will need to stretch its advertising and sales functions to meet cash flow requirements in the near future. The Texas attorney general has entered a lawsuit against TaxMasters, accusing the company of routinely misleading customers about its services. As previously explained, “stretching” will mean advertising unrealistic claims and pushing sales forces to “qualify” (sell) taxpayers for tax settlements for which they either do not qualify or, when negotiated, cannot afford.
For TaxMasters and most other national tax resolution firms, complying with the TSR will be devastating for their business model. Although TaxMasters and other companies have publicly stated that they are going to abide by the TSR, their business model or advertising has not yet changed. For example, as of Nov. 16, 2010, TaxMasters was still advertising under keywords for settling tax debt, three weeks after it stated that it would comply with the TSR. Here is the “settle tax debt” first page, sponsored Google results as of Nov. 16, 2010.
In reality, TaxMasters is trying to find a way to charge upfront fees by separating its services into an initial “compliance” fee and then selling the consumer on more settlement services. In any event, TaxMasters advertising seems to contradict its claim of offering debt settlement last, as evidenced by its primary message to the marketplace, advertising for consumers to purchase debt relief services.
There are other examples of the tax resolution business model in class action lawsuits, attorney general complaints and FTC enforcement. JK Harris, Roni Deutch and American Tax Relief complaints all illustrate a similar business model and deceptive practice claims by consumers and enforcement agencies.
As a result of little regulation of tax debt settlement companies, a self-perpetuating cycle of unethical practices has emerged. Now, to continue operating, tax debt settlement companies find that they must push the legal and ethical boundaries to sustain their business model.
Tax Debt Companies and Applicability of the TSR
In July 2010, the FTC defined “debt relief service” to cover all types of unsecured debts, including medical or tax debts owed to the government. In an effort to maintain cash flow by finding an exclusion for the advanced-fee ban, TD relief companies have consorted and lobbied for loopholes in the TSR.
Specifically, there are two main loopholes that are being pursued in the lobbying effort:
- Segregation of services allows for back-end fees to be related only to TD relief services.
- Tax debt is secured debt and therefore not covered under the TSR.
The FTC has warned about the segregation of services into nondebt services and debt relief services to avoid the advanced-fee limitation. Some firms are attempting this loophole. However, the entire service offered by TD relief firms is tax relief. They do not advertise services clearly divided into debt vs. nondebt services, and it is absurd to believe that consumers will view the services as segregated. Instead, this attempt will result only in further semantic games played at the expense of consumer protection and transparency. These companies will address and “alter the terms of payment,” as called for in the TSR statute, by providing tax debt extensions from the IRS while they complete “compliance services.” Compliance and IRS enforcement management are part and parcel of tax debt relief. Bifurcating these services is an attempt to find a legal loophole and avoid the intent of the law.
On Oct. 27, 2010, the FTC announced that it would defer enforcement of the TSR to tax debt settlement companies, to allow the FTC to consider whether the Rule applies to them. Specifically, the tax debt settlement industry lobbied for the FTC to consider tax debt as secured debt and, therefore, not subject to the TSR.
The question of whether tax debt is secured and not subject to the TSR depends on the legal interpretation. Tax debt is a unique type of debt, and many factors need to be considered. Also, logistically, TD relief companies will not be able to determine whether their customers’ tax debt is secured under any legal definition before taking advanced fees.
There are two types of liens on an unpaid tax debt.
The first is the statutory lien, which is established when three requirements are met:
- A tax assessment is made.
- A notice and demand for payment are made (i.e., the first IRS notice for an unpaid liability).
- The taxpayer neglected or refused to pay the tax in the time prescribed in the notice.
Practically, this lien is not perfected and may or may not be in IRS collections enforcement. The first IRS notice for payment may occur several weeks after filing a tax return or after the IRS makes an assessment. This letter requests that the taxpayer pay within 10 days. Hence, the statutory lien may be several weeks after filing or assessment.
The second type of lien is traditionally considered secured in the legal form. This occurs when the IRS files a public Notice of Federal Tax Lien (NFTL). Section 6323(a) provides that the FTL is not valid against purchasers, holders of security interests, mechanic’s lien creditors and judgment lien creditors until an NFTL is filed. The tax lien becomes valid (i.e., secured) against most other creditors at the time the NTFL is filed properly.
It is important to note that the IRS does not always file an NFTL. For example, IRS collection personnel are not required to, and often do not, file an NFTL if the taxpayer owes less than $5,000. This is true even if the taxpayer does not agree to pay the IRS. Also, if the taxpayer owes less than $25,000 of assessed tax and is in a payment plan to satisfy the debt with the IRS, the IRS will generally not file a tax lien. Given that more than 87% of taxpayers owe less than $10,000 and 76% owe less than $3,000, many taxpayers do not have an NTFL. Thus, if the NFTL defines when a tax debt is secured, then most tax debt is unsecured. Also, it would be presumptuous of a TD relief company to treat a taxpayer’s debt as automatically secured because some (or none) of his or her debt may meet the requirements for statutory or NTFL filed debt. Therefore, the secured-debt exclusion is logistically impossible to determine before a trained professional analyzes and determines ALL of the facts of a particular case.
In any event, the FTC specifically included TD relief companies into the TSR for a reason: to protect the consumer from deceptive practices. The intent of the law was also to protect tax debtors. Allowing TD relief companies to continue their practices based on this loophole would be a travesty of justice.
Deceptive Advertising and Practices are Prevalent in the Tax Debt Relief Industry, Requiring Regulation to Protect Consumers
TD relief companies charge substantial advance fees to consumers for their services. They can charge these fees because consumers believe that a very painful issue, tax debt, can be routinely settled with their expertise.
Consumers are led to believe that TD relief companies have “inside” knowledge, use proprietary negotiation tactics, can accomplish extraordinary outcomes and can stop the IRS collection process. Most TD relief companies advertise uncommon yet attractive solutions to financially distressed taxpayers.
TD relief companies also cause harm to consumers because they violate the fiduciary duty that they have in representing a taxpayer before the IRS. When a taxpayer engages a TD relief company, the licensed representatives of that company become the consumer’s fiduciary and legal agent to the IRS. This happens when taxpayers authorize TD relief company representatives to act as their power of attorney for all matters before the IRS. When the company does not provide its services in a timely manner (either due to the inevitable client overload resulting from the business model or because it waits until substantial fees are received), the result is often significant damage to the taxpayer. From the IRS’s perspective, the negligence or inaction of the TD company becomes the action of the taxpayer, putting the taxpayer at risk for IRS enforcement with levies, liens, audits, penalties and other actions.
There are many examples of deceptive practices that are prevalent in the TD relief industry. For example:
- TD industry advertising relies heavily on the Offer in Compromise (OIC) solution—a solution available to very few. As of Sept. 30, 2009, the IRS was pursuing 9.7 million taxpayers for delinquent tax obligations. For the entire 12 months prior to Sept. 30, 2009, the IRS accepted only 10,677 offers. These results indicate that about one in every 879 taxpayers receives an OIC. In the Roni Deutch lawsuit, the California Attorney General’s Office stated that Deutch’s firm got an OIC for 10% of her clients—far less than the 99% success rate purported in her advertising.
- TD relief companies use “bait and switch” tactics to extract fees from their clients. Their advertising messages consistently mislead and prey on people who do not have everyday access to professional help. The companies use dishonest statements such as “act fast—you have a limited time to settle” and “our experts can negotiate your debt for pennies on the dollar.” In reality, the IRS has never offered an “amnesty” program. The OIC is not a new program for the IRS, nor is it a “soon to expire” program as some firms claim in their efforts to motivate quick decisions on the part of taxpayers. Furthermore, there is little negotiation involved with an OIC. It is computed based on an IRS formula for “reasonable collection potential.” In the vast majority of cases, negotiation has little, if any, significance in the process.
In most TD relief circumstances, fees are charged before the customer discovers the “bait and switch” or lack of service. Because the process of “settling” tax debt is approximately 9 months, most consumers have already paid substantial amounts on their service agreement with the TD relief company. Furthermore, most firms delay until fees are paid and never even file for the promised settlement. Couple this with the fact that the IRS accepts, in total, 25% of offers filed, and consumers will not discover the “bait and switch” until long after their fees have been paid. As a result, without an advance-fee limitation, consumers have no recourse to get their fees refunded when they do not receive the promised services (see the TaxMasters suit by the Texas AG’s office).The company has already spent the funds on more advertising. Refunds for lack of service and promised outcomes are practically nonexistent in the TD relief industry. This is due to complex service agreements containing fine print that allows the TD relief company to retain fees for services already provided, even if they are not what the consumer expected.
Consumers need more control of the fees paid to these companies to allow them to hold TD relief companies accountable and ensure that they deliver the promised results. This will go a long way toward protecting the consumer from abuses in this agency relationship, as well as financial loss resulting from negligence and/or deception.
The tax debt relief industry will not regulate itself to eliminate consumer abuses
The business model and its resulting consumer abuses are prevalent in the tax debt relief industry. The complaint by California’s attorney general illustrates normal activity in the industry. Furthermore, the industry does not appear to want to regulate itself in a manner that would protect the consumer. This is evidenced in its current advertising methods and the business model adjustments being undertaken in attempt to circumvent the advanced-fee ban in the statute.
It is not feasible to rely on the Internal Revenue Service to protect consumers, either. The IRS does not have consumer protection authority, nor can it regulate TD relief companies. The IRS can and does regulate CPAs, enrolled agents and attorneys (and tax preparers, beginning in 2011) through its Office of Professional Responsibility (OPR). The rules of practice before the IRS are outlined in Treasury Department Circular 230. However, TD relief companies are not practitioners as defined in Circular 230; only the licensed practitioners whom they employ or with whom they contract are regulated by OPR and Circular 230. Hence, the IRS has only sent consumer alerts about these companies but has not initiated any enforcement of deceptive practices because it is unable to do so.
Similar to other debt settlement companies, TD relief companies do not have an enforceable standard of ethical practice in their industry. Unlike state CPA Boards for accounting and state Bar Associations for law practice, the TD relief industry is without an independent authority to set rules and best practices, monitor behavior and act on customer complaints. Lack of oversight has led to various attorney general office complaints, class action suits, and FTC actions. However, by the time these methods are employed, the damage has been done and there is little, if any, recourse available to the consumer.
My position on the applicability of the TSR advanced fee limitations to tax debt relief companies
It is clear that many companies in the tax debt relief industry will not hold themselves upright, as evidenced by their deceptive advertising methods and the business model adjustments being undertaken in attempt to circumvent the advanced-fee ban in the statute. It is also evidenced in the numerous complaints filed and lawsuits undertaken against those within the industry. The result of this lack of oversight is direct and ongoing harm to the consumer. Clearly, this industry, similar to the debt settlement industry, needs regulatory oversight.
I believe that the TSR advanced-fee limitation should apply and be enforced on the tax debt settlement/relief companies in the same manner that it is enforced on the debt settlement industry, as of Oct. 27t, 2010. I take this position because the business model and operations of most tax debt companies do not protect the interests of the consumer. Consumers need to be in control of the fees paid to TD relief providers, empowering them to hold the companies accountable for their services.
I also believe that the secured-debt “loophole” is not justified, nor is it the intent of the TSR to exclude the entire industry simply because some of the debts may be considered secured under the Internal Revenue Code. Even if tax debt is, at some point, considered secure, it is incorrect to state that all tax debt is secure. TD relief companies wish to presume that all of their clients’ tax debt is secured and therefore not contemplated under the TSR. However, such a presumption would be both improper and logistically impossible for the companies to know with certainty, prior to receiving fees for their services. Applying this loophole would break the spirit of the law, as well as put consumers at risk for deceptive practices.
I strongly advocate that your office reinstate enforcement of the advanced-fee limitations on tax relief companies immediately to protect the consumer.
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