With much fanfare, Governor Rod Blagojevich signed the Illinois Adoption Reform Act into law last Sunday, August 14, 2005. While very well-intended, this law will prove to be a disaster for the tax system. Those of you who are familiar with the IRS battle with credit counseling agencies will instantly recognize the inherent näitivity. Specifically, the law requires that any child welfare agency providing adoption services must be a...
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This law is offensive from a philosophical standpoint. Underlying this legislation is the belief that only charities are qualified to deal with the sensitive issues that arise as part of the adoption process. “We don’t want crass profiteers selling babies.” While that sentiment is superficially appealing, it is clearly superficial. It reflects a very poor view of business and the for-profit sector. But more to the point, who says tax status is a good predictor of ethics and morality, particularly when it comes to children? The Catholic Church, a charitable organization, has hardly been a paradigm in recent years when it comes to protecting the interests of children and young adults. And anyone examining the tort of negligent hiring will find plenty of successful lawsuits against Section 501(c)(3) organizations. We are not condemning the Catholic Church or these other organizations. We are simply noting that all organizations, be they for-profit or non-profit, are staffed by people. When there are problems, it is people who cause them, not organizations.
Setting aside its philosophical failings, the law will also prove to be ineffective in curbing abuses, at least the provisions mandating Section 501(c)(3) status. During the last three or four years, the IRS has been engaged in a massive effort to audit credit counseling agencies operating as Section 501(c)(3) organizations. Credit counseling abuses appear as Number 4 on the IRS’s list its 2005 Dirty Dozen of Exempt Organization abuses, with IRS Announcement 2005-19 proclaiming:
Credit Counseling Agencies. Taxpayers should be careful with credit counseling organizations that claim they can fix credit ratings, push debt payment agreements or charge high fees, monthly service charges or mandatory “contributions” that may add to debt. The IRS Tax Exempt and Government Entities Division has made auditing credit counseling organizations a priority because some of these tax-exempt organizations, which are intended to provide education to low-income customers with debt problems, are charging debtors large fees, while providing little or no counseling.
You might wonder why the IRS is worried about debtors charging large fees for little or no service. Isn’t the IRS charged with administering the tax laws?
We have heard the IRS Commissioner speak on this subject. There is no doubt that significant IRS enforcement resources were diverted to addressing tax abuses posed by many credit counseling agencies. What is troubling about this is that the IRS is not a consumer protection agency, yet the states shifted their consumer protection duties to the IRS when they mandated that credit counseling agencies be operated as non-profits. This is exactly what Illinois has just done in the case of adoption agencies.
Many states decided that there were serious abuses by some credit counseling agencies. Like infants, those requiring the services of credit counseling agencies are a vulnerable population. Consequently, a number of states required that credit counseling agencies could only be operated as non-profits. This was an indirect solution to a known problem. The better course of action would have been to treat credit counseling abuses as a consumer protection matter. This would have meant prohibiting certain practices; placing enforcement where it squarely belonged, with state consumer protection agencies.
As should have been expected, some for-profit credit counselors converted to non-profit status. Of course, they wanted their profits, but were faced with prohibitions under both state non-profit corporation law and tax law against paying dividends to non-existent equity owners. As a consequence, some of those behind what were flimsy Section 501(c)(3) organizations used leases, management agreements, and compensation payments to strip the profits out of their organizations while still providing credit counseling services as non-profit organizations. We strongly suspect that this same phenomenon will repeat itself in the years to come with some Illinois child welfare organizations. To the extent that these evil profiteers provide substandard adoption services, all Governor Blago and the Illinois legislature have done is shifted the battleground from direct regulation of abuses to disputes involving the IRS intermediate sanctions and private inurement—a battleground that will not protect vulnerable children. Fortunately, recent changes to IRS Form 1023 will make it more difficult for those seeking profits to obtain tax-exempt status, but some people will be well counseled, permitting them to slip under the IRS’s radar screen. But why should the State of Illinois make the IRS the gatekeeper?
Moreover, this will not entirely be the IRS’s problem. The Illinois Attorney General will also enter the picture. But rather than using consumer protection laws to fight “bad” actors, the fight will be over the protection of charitable assets. That will prove to be a much more difficult fight to wage because it will be over economic issues (e.g., reasonable compensation) rather than stolen babies. If there is any doubt, the Illinois Attorney General should place a call to those running the Charities Division of the Massachusetts Attorney General. We saw a presentation earlier this year by the attorneys involved in a lawsuit that the Massachusetts Attorney General brought against one credit counseling agency. It was clear to us after listening to that presentation that the lawsuit was really a consumer protection action that should have been handled by the consumer protection division of the Massachusetts Attorney General’s office rather than the Charities Division. Unfortunately, as this attorney confirmed when we asked why the lawsuit was not over consumer protection issues, the state legislature had forced the Massachusetts Attorney General to fight the battle using the state’s charity laws rather than consumer protection laws. That is exactly what Governor Blago and Illinois legislature have regrettably just done. Requiring Section 501(c)(3) status will not curb the abuses, but it will shift law enforcement efforts to agencies that are not properly-equipped to deal with the abuses that gave rise to the Illinois legislation. Moreover, it may drive certain for-profit adoption agencies out of business even though those agencies were providing excellent service to their clients.
Those Illinois non-profits that are already providing adoption services should not be pleased with this legislation, either. To the extent it does drive "bad actors" into the non-profit organizational form, the legislation is likely to result in additional expense to legitimate non-profits through increased IRS surveillance and audits.
We are clearly not experts in child adoption practices, legislation, or regulation. In an effort to learn what those behind this legislation had to say about our concerns, we called both Governor Blagojevich’ office, as well as Representative Sara Feigenholtz’s office, our state representative. The Governor’s office was largely non-responsive (well, it is August) and we still have not received a promised call back from someone in Representative Feigenholtz’s office (three or four days later).
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