IRS Denies 501(c)(3) Status to Bankruptcy Counseling Agency

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On April 29, 2011, the Internal Revenue Service (“IRS”) issued Private Letter Ruling (“PLR”) 201117036 denying a nonprofit credit counseling agency (“CCA”) tax-exempt status under Section 501(c)(3) of the Internal Revenue Code (“Code”) because its primary activity would have been the provision of prebankruptcy certification and post-bankruptcy counseling for fees.

Although not the first piece of guidance to address the tax-exempt status of credit counseling agencies, this private letter ruling – addressing the particular facts of one organization – provides insight into the IRS's approach regarding bankruptcy counseling and debtor education providers, and could have a significant impact on a large number of credit counseling agencies. The impact may be more far-reaching than merely bankruptcy counseling and debtor education, and may result in a rethinking of counseling methodology and business relationships for debtor education – as well as sources of funding across the industry.

Legal Framework

As a result of amendments to the federal bankruptcy code under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”), with limited exceptions, federal law now requires that people who plan to file for personal bankruptcy protection must obtain a certificate of completing credit counseling from a government-approved organization within 180 days before they file. They also must complete a debtor education course from an approved provider to have their debts discharged. Present regulations allow services to be provided in-person, via the Internet, or by telephone.

Consistent with the BAPCPA, for the pre-filing counseling certification mandated by the law, taxexempt status under Section 501(c)(3) is not required for approval as a budget or CCA under the BAPCPA, however, nonprofit status (typically incorporation as a nonprofit corporation) is a prerequisite, among other requirements. For the pre-discharge debtor education mandated by the BAPCPA, providers of financial management instructional courses can be either nonprofit or for-profit entities.

Code Section 501(c)(3) exempts from federal income tax corporations organized and operated exclusively for charitable, educational and other purposes, provided that no part of its net earnings inures to the benefit of any private shareholder or individual. In addition, Section 501(q) of the Code states that an organization that provides credit counseling services will not qualify for exemption under Section 501(c)(3) unless it is organized and operated in accordance with the highly specific requirements laid out in Section 501(q). These requirements include that the organization provide credit counseling services tailored to the specific needs and circumstances of consumers, and that the organization is organized and operated in accordance with a number of additional specified requirements.

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Published In: Administrative Agency Updates, Bankruptcy Updates, Nonprofits Updates, Tax Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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