The "debt indicator" acts as a form of credit check, telling tax preparers whether a taxpayer's refund will be paid or will be intercepted for government debts.
"As we prepare for tax season every year, we look at past practices and consider whether they still make sense. We no longer see a need for the debt indicator in a world where we can process a tax return and deliver a refund in 10 days," IRS Commissioner Doug Shulman said. "We encourage taxpayers to use e-file with direct deposit so they can get their refunds in just a few days."
So far this year, more than 95 million tax returns have been e-filed, representing more than 70 percent of tax returns.
"Refund Anticipation Loans are often targeted at lower-income taxpayers," Shulman said. "With e-file and direct deposit, these taxpayers now have other ways to quickly access their cash."
"We are pleased that IRS has decided to stop aiding and abetting high cost RALs that siphon off hundreds of millions in taxpayers' hard-earned money and federal benefits meant to lift the working poor out of poverty," said Chi Wu, National Consumer Law Center (NCLC) staff attorney.
The IRS has been reviewing refund settlement products, such as RALs and Refund Anticipation Checks (RACs), as part of the Return Preparer Review released in January. Specifically, the IRS announced that it would study refund settlement products.
Secured loans
RALs are loans secured by a taxpayer's anticipated tax refund. Currently, tax preparers who electronically submit a client's tax return receive in the acknowledgment file an indication of whether an individual taxpayer will have any portion of the refund offset for delinquent tax or other debts, such as unpaid child support or delinquent federally funded student loans. This acknowledgment is known as the debt indicator, and is used as an underwriting tool for RALs.
"The federal government should not be sharing taxpayers' personal information for the profit of banks and tax preparers by operating what is essentially a free credit reporting service for them," said Jean Ann Fox, director of financial services for Consumer Federation of America (CFA). "We are glad the IRS finally stopped letting tax preparers and banks pry into taxpayers' records about what they owe the government."
The IRS announcement would remove the debt indicator starting with the upcoming 2011 tax-filing season. The agency that taxpayers will continue to have access to information about their tax refunds and any offsets through the "Where's My Refund?" service.
RACs are temporary bank accounts established on behalf of a taxpayer into which a direct deposit refund can be received and out of which a bank typically issues a payment to the taxpayer.
With both RALs and RACs, tax preparation and product fees are subtracted directly from the refund, and the taxpayer does not make any "out-of-pocket" payments. They are frequently marketed to taxpayers who do not have cash to pay for professional tax preparation services.
The NCLC and CFA have been urging the IRS to end the debt indicator since 2005, when they published a report entitled "Corporate Welfare for the RAL Industry: The Debt Indicator, IRS Subsidy, And Tax Fraud."
Their most recent criticism of the debt indicator was during the IRS Commissioner's Return Preparer Review Forum in August 2009, in which they again urged the IRS to discontinue the program.
In a related effort, the IRS plans to explore the possibility of providing a new tool for the 2012 tax filing season to give taxpayers a mechanism to use an appropriate portion of their tax refund to pay for the services of a professional tax return preparer.
The IRS plans to engage with taxpayers, consumer advocates and the tax return preparer community to consider whether providing this option would be a cost-effective way for consumers to pay for tax return preparation services.
