Taxpayer, Government Lose With Quickie Refund Loans

High fees drain money and constrain spending power

March 3, 2009

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With the tax season in full swing, another year has passed in which tax preparers and their partner banks drained hundreds of millions of dollars from refunds by selling refund anticipation loans (RALs), mostly to millions of working families who get the Earned Income Tax Credit.

An annual report issued by the National Consumer Law Center (NCLC) and Consumer Federation of America (CFA) shows that RALs drained the refunds of about 8.7 million American taxpayers in 2007, the last year on which the Internal Revenue Service provided data.

This represents about $833 million in loan fees, plus over $68 million in other fees. In addition, another 11.2 million taxpayers spent $336 million on related financial products to receive their refunds.

"Not only do RALs siphon off hundreds of millions from the hard-earned tax refunds of American taxpayers, they also undermine the integrity of our tax system," said Chi Chi Wu, NCLC Staff Attorney, "Banning or reforming RALs would save money for taxpayers, and help the federal government reduce fraud and inaccurate filings."

The report also discusses the need for Congressional action to stem the drain posed by RALs. A key development in 2008 was a decision by the Second Circuit Court of Appeals that obstructs the ability of states to regulate RAL fees. If correct, the Second Circuit's decision means that only Congress can cap RAL rates.

Lawmakers have introduced the "Protecting Consumers from Unreasonable Credit Rates Act" that would cap interest rates for RALs, and other predatory loans like payday loans and auto title loans, to 36 percent.

"The Protecting Consumers from Unreasonable Credit Rates Act would stop RAL and other predatory lending abuses cold in their tracks," said Jean Ann Fox, Director of Financial Services for CFA, "That will put more dollars in the wallets of hard-working Americans. Cleaning up RALs and the finance industry in general is essential to a sustainable economic recovery."

RALs are bank loans secured by the taxpayer's expected refund — loans that last about 7-14 days until the actual IRS refund repays the loan. That's a good indication of just how needless most RALs are: Most taxpayers could have their refund in two weeks or less even without the costly loan.

Using the most recent data available from the IRS, NCLC and CFA calculate that about 8.67 million taxpayers received RALs in the 2007 tax-filing season (for tax year 2006). For that year alone, about one in 15 tax returns involved a RAL. In addition, 11.2 million taxpayers received a refund anticipation check in 2007, at a cost of about $336 million. Nearly two-thirds of RAL borrowers are EITC recipients, even though they only make up about 17 percent of taxpayers.

The price of a RAL includes several components:

• A loan fee ranging from $34 to $130, which is usually broken down into a "Refund Account" fee and a "Bank Fee."

• Some tax preparers may charge one or more separate add-on fees, sometimes called "application," "administrative," "e-filing," "service bureau," "transmission," or "processing" fees. Add-on fees can range from $25 to several hundred dollars. Add-on fees are not charged by H&R Block, Jackson Hewitt or Liberty Tax.

In general, the effective annual interest rate for a RAL can range from about 50 percent to nearly 500 percent. If a $40 add-on fee is charged and included in the calculation, the effective APRs range from about 85 percent to nearly 1,300 percent, the groups said.

RAL loan fees can vary significantly. H&R Block and JPMorgan Chase generally have lower RAL fees. In fact, they claim that these loans effectively bear APR of 36 percent. However, this does not include the "Refund Account" fee, which they claim is for the temporary account into which the taxpayer's refund is later deposited to repay the RAL. If the Refund Account Fee is included, it more than doubles the APR.

Nonetheless, there are some real and significant price differences between various RAL outlets. For example, a RAL in the amount of $3,000, which is typical, costs from $62 to $110.

In addition to draining the refunds of consumers, RALs have a negative impact on the integrity of tax administration, the groups charge. They promote tax fraud by preparers, and attract questionable fringe preparers into the tax preparation business.

Fringe preparers include payday lenders, check cashers, pawn shops, rent-to-own stores, auto title lenders, used car dealers, travel agents, shoe stores, beauty salons, furniture stores, grocery stores, jewelry stores, liquor stores, and even an occasional "therapy" office.

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