The 2013 tax season is officially in full swing, and this year consumers no longer have to worry about refund anticipation loans (RALs). RALs are short-term, high-interest, payday loan-style bank loans sold through tax-preparation sites. The allure of RALs is that they provide taxpayers an immediate advance on their anticipated tax refunds; however, like payday loans, RALs have usurious interest rates and hidden fees. Fortunately, tax preparers will no longer be able to offer RALs this tax season.
In 2010, the Internal Revenue Service (IRS) stopped providing its “debt indicator” device to tax- preparers. As a result federal banking regulators such as the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC) issued cease and desist orders to banks funding RALs. According to federal banking regulators, because the IRS debt indicator was no longer available, tax preparers’ ability to adequately underwrite RALs was undermined. Banks were, therefore, engaging in unsound lending practices when making loans to tax preparation companies to fund RALs. The effect of these cease and desist letters was to prohibit banks from lending to tax preparers, forcing them in turn to cease offering RALs as of the 2012 tax season. Thus, in 2011 only 750,000 RALs were issued.
Unfortunately, since tax-preparers earned millions from RALs (a high of $1.24 billion at their height in 2004), and they are no longer allowed to offer them, they have switched to a similar product that hasn’t been subjected to the same scrutiny by federal regulators: Refund Anticipation Checks (RACs). RACs are temporary bank accounts set up by the tax-preparer on behalf of a taxpayer into which the IRS direct deposits a refund check. Consumers access the money through a check or prepaid card. Consumers typically pay about the $30 to set-up the one-time use account.
A recent report by the National Consumer Law Center (NCLC) looks at RAC growth in recent years. In 2009 12.9 million taxpayers used RACs at a cost of $387 million. By 2011, the number of RAC consumers grew to 18.3 million taxpayers paying about $550 million. Given that RALs are no longer offered, the number of RACs issued is likely to grow in 2013.
According to the NCLC report, many tax-preparers engage in deceiving practices that allow them to squeeze as much money as they can from consumers. Tax-preparers often charge add-on fees such as document processing or e-filing fees. Thus, the report estimates that RAC consumers paid a total of $140 million in add on fees in 2011. The study also points out that many people use RACs to pay for the services of the tax-preparer, which ultimately serves as a loan with a usurious interest rate. For example, a person is, in essence, paying $30 to defer a $200 tax-preparer fee for three weeks when they use a RAC. The annual percentage rate (APR) equivalent here is 260%. In addition, by allowing taxpayers to deduct the cost of tax-preparation from the RAC, the consumer is less sensitive to the cost of tax-preparation. Finally, a 2010 study using “mystery shoppers” revealed that many tax-preparers automatically sell RACs to consumers without consumers’ knowledge.
The NCLC report also warns about the new nonbank RALs, which have been sold to a few hundred thousand consumers thus far. These RALs are being offered by high-cost non-bank lenders such as payday lenders and other non-bank businesses that have stepped in to replace the banks that can no longer finance RALs. Nonbank RALs are riskier and more expensive to consumers; however, according to the report, such products have yet to really take off.
The largest issue surrounding RACs is that they allow tax-preparers and banks to profit from the Earned Income Tax Credit (EITC). The EITC is the nation’s largest federal anti-poverty program providing nearly $58 billion to 26 million families in 2011. The EITC is meant for low-income people earning incomes near the federal poverty level. According to the NCLC, EITC recipient who purchased RACs and RALs paid a total of $2.2 billion to tax-preparation organizations. Theoretically 100% of the this money should be in the hands of low-income people, but because our tax system is so contrived, complex, and inefficient, tax-preparation companies like H&R Block and Jackson Hewitt are able to siphon off a large chunk of this money (almost 4%).
Ultimately, the federal government needs to make it simpler for people to access their tax refunds faster and more easily. The Treasury Department ran a pilot program offering the unbanked and underbanked tax refund initiated bank accounts. This demonstration project showed a lot of promise and could be brought to scale. Additionally, the IRS now allows consumers to check the status of their tax refunds online at the “Where’s my refund” website. Consumers who file their taxes digitally can expect to receive their refund in fewer than 21 days—the same time frame for receiving a RAC. Finally, consumers should be encouraged to take advantage of the free Volunteer Income Tax Preparation (VITA) sites across the country, so that they don’t waste their hard-earned money on unnecessary tax preparation schemes. All consumers should be able to access 100% of their tax-returns.
To read more about the demise of RALs see our previous blogs.