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Inside IRS Denial of Credit Counseling Application – Letter 4038

Today I’m taking another look at IRS documentation involving non-profit 501(c)(3) actions. It’s important to take a look at these documents to understand what the IRS feels is appropriate activity or behavior of credit counseling groups.

This letter was issued to a new group that wanted to be approved as a non-profit credit counseling group and was denied. The IRS said they were going to notify the appropriate State officials of their denial as well.

The group stated in their application they were to be formed exclusively for charitable, religious, educational and scientific purposes.

The organization was organized, directed, and managed by one person. The bylaws state the organization may have shareholders.

The IRS noted the conflict of dual intended purposes of the organization. On one hand they were to assist consumers to repay creditors to avoid bankruptcy, but at the same time they were formed to comply with the United States Trustee Program to provide counseling for individuals to file bankruptcy.

The group said they will not limit services to a particular class of people, such as minorities, low-income individuals or the elderly.

The IRS noted that the limited board which did not represent the “broad interests of the public” was a problem. It stated, “Not more than 20 percent of the voting power of the board of directors can be vested in persons who are employed by the organization or who will benefit financially, directly or indirectly, from the organization’s activities. Furthermore, not more than 49 percent of the board may be employees of the organization, creditors, or those who will benefit financially.”

The IRS also noted they felt that as a “charitable” organization it is generally accepted that is aimed at the relief of the poor and distress or of the under privileged as well as the advancement of education.

Educational refers to:

  • “The instruction or training of the individual for the purpose of improving or developing his capabilities; or
  • The instruction of the public on subjects useful to the individual and beneficial to the community.”

The IRS laid out its case why the credit counseling group did not meet the requirements.

  • The group would operate for a substantial non-exempt purpose.
  • Income would pass to the benefit of the sole board member.
  • The provision of pre-bankruptcy credit counseling for a fee was a non-exempt commercial purpose. “You devote all of your time and activities to selling pre-bankruptcy certifications to the general public under the guise of financial education.”
  • The organizational activities appear to have an underlying commercial motive.
  • Services are rendered in exchange for a fee, as in a commercial organization.
  • Credit counseling is not limited to a charitable class of individuals.
  • The group did not make their fee waiver policy easily available to the public.
  • There is little in the way of public contributions but primarily fees from commercial activities.
  • There was no substantive on-going educational program.
  • The group did not provide any support to demonstrate they were planning to dedicate significant revenues to activities involving educational and/or charitable programs.
  • The governance of the organization violated 501(q) in that the board must be controlled by persons that represent the broad interests of the public, “such as public officials acting in their capacities as such, persons having special knowledge or expertise in credit or financial education, and community leaders.”

If you would like to read the entire denial letter, click here.


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About Steve Rhode

Steve Rhode
Steve Rhode is the Get Out of Debt Guy and has been helping good people with bad debt problems since 1994. You can learn more about Steve, here.

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