BOSTON – The W-2s have all been sent and it’s the height of the tax season in poor communities, especially for the millions of working families who get the Earned Income Tax Credit (EITC). Yet again, tax preparers and their partner banks will be siphoning off hundreds of millions of dollars from these refunds by selling high cost refund anticipation loans (RALs).
The National Consumer Law Center (NCLC) and Consumer Federation of America (CFA) estimate that approximately 12.38 million American taxpayers spent an unnecessary $1.6 billion in 2004 (the latest year for which data is available) to obtain their refund monies faster by two weeks or less than if they used electronic filing and direct deposit. NCLC and CFA today issued their latest annual report on the RAL industry, entitled “Another Year of Losses: HighPriced Refund Anticipation Loans Continue to Take a Chunk Out of Americans’ Tax Refunds.”
“RALs are a bad deal for taxpayers, who can save themselves over a billion dollars by avoiding these exorbitantly priced loans,” says NCLC staff attorney Chi Chi Wu. Advice for consumers on better alternatives to RALs is available in the NCLC brochure “Don’t Pay to Borrow Your Own Money,” attached and also on-line at www.consumerlaw.org/initiatives/refund_anticipation/content/RALBrochure.pdf.
RALs Examined
RALs are extremely high-cost bank loans secured by the taxpayer’s expected tax refund – loans that last about 7-14 days until the actual IRS refund repays the loan. The fact that the loans last for such a short period of time shows how unnecessary most RALs are: Taxpayers can get their refunds in two weeks or less even without the costly loan.
“If you want a fast and free refund, you can get it in two weeks or less by using electronic filing and having refunds direct deposited into your own bank account,” says Jean Ann Fox, director of consumer protection for CFA, “If you don’t have a bank account, getting a big refund is a good time to open one up.”
RALs cost from $29 to $120 in loan fees. Some tax preparers also charge a separate fee, often called an “administrative” or “application” fee; however, this fee will become less common now that the largest commercial preparer chains have eliminated it for all or some of their offices. Tax preparers and their bank partners also offer an “instant” same day RAL for an extra $20 to $45.
The effective annual interest rate (APR) for a RAL can range from about 40% (for a loan of $9,999) to over 700% (for a loan of $200). If administrative fees are charged and included in the calculation, RALs cost about 70% to over 1,800% APR.
RAL usage has stayed flat, but the numbers are still alarmingly high. Using the most recent data available from the Internal Revenue Services (IRS), NCLC and CFA calculate that somewhere in the neighborhood of 12.38 million taxpayers received RALs in the 2004 tax filing season (for tax year 2003). For that year alone, about 1 in 10 tax returns involved a RAL. These 12.38 million RALs represent a slight increase from the 12.15 million RALs taken in 2003. These consumers paid a total of $1.24 billion in loan fees, plus $360 million in administrative fees (since they were still being charged in 2004), for these loans.
This year, a RAL for the average refund of around $2,150 will cost about $100. A loan under those terms bears an effective APR of about 178%. If the taxpayer goes to a preparer who charges an additional $30 administrative fee, the effective APR including the administrative fee would be 235%. These loan charges are in addition to tax preparation fees averaging $146, so the grand total could be as high as $276.
RALs Target Working Families
The biggest target for RALs are the low-wage workers who claim the EITC. RALs drain hundreds of millions of dollars from the EITC, lining the coffers of multi-million dollar corporations with tax dollars meant for poor families with children. Over 56% of all RAL borrowers are EITC recipients according to IRS data, despite the fact that EITC recipients only make up 17% of taxpayers. One out of every three EITC recipients gets a RAL.
“This is a form of corporate profiteering,” stated NCLC’s Chi Chi Wu. “It’s a shame that big banks and commercial preparers pocket a chunk of anti-poverty benefits meant to help hardworking Americans.”
Based on IRS data for 2004, NCLC and CFA estimate that 7 million working poor families spent over $900 million in RAL fees in order to get their tax refund monies less than two weeks sooner than they otherwise could. These families paid about $700 million in RAL loan fees and $204 million in administrative fees. In terms of other fees, these families paid $1 billion in tax preparation fees, and about 45% of them spent approximately $205 million to cash their RAL checks with check cashers.
Data on RAL Users
A telephone polling survey commissioned by the Consumer Federation of America provides new information about RAL users. The national survey found that RAL users are vulnerable to quick cash loan offers. RAL users are more likely than non-RAL users to be less well educated, work in service or semi-skilled/unskilled jobs, rent instead of own their homes, be female and African American. RAL users are also heavier users than non-RAL users of other high cost fringe financial services, such as rent-to-own, payday loans and pawnshop loans. These consumers are more likely to be unbanked than non-RAL users and those who do have bank accounts are more likely to have overdrawn in the past year.
“Tax preparers are snaring cash-strapped families who can least afford to pay triple-digit interest rates for quick cash,” said Jean Ann Fox of CFA. “Instead of getting RALs, EITC recipients need every dollar of their refunds to escape debt and set aside emergency funds.”
The survey was conducted by Opinion Research Corporation in early November 2005 and interviewed 2,038 representative adult Americans. The margin of error for the sample is plus or minus two percentage points.
Free File
A significant development in 2005 occurred when the IRS renewed its agreement with the Free File Alliance to provide for free Web-based electronic filing for taxpayers who make less than $50,000 annually. Unfortunately, this new agreement does not ban Free File commercial preparers from marketing RALs to taxpayers. Since taxpayers reach Free File preparers by going through www.irs.gov, the agreement continues to permit the appearance of an implicit government endorsement of the marketing of RALs and other ancillary products, such as audit “insurance” or preparing state tax returns. This new agreement also will not benefit the millions of lower income consumers who are on the other side of the “digital divide” without computer and Internet access at home.
The NCLC/CFA Report notes that Congressional pressure was placed on the IRS to enter this agreement, including a threat to ban the agency from developing its own software to permit direct electronic filing. According to Chi Chi Wu of NCLC, “It’s hard to believe that taxpayers can’t file their taxes electronically directly with the IRS and must go through a third party. It’s even harder to believe that some in Congress want to prevent the IRS from fixing this problem and moving into the 21st Century.”
New Laws, New Products
Several states have passed new laws to address RALs, including the first law in the nation to cap RAL loan rates. Connecticut passed a law to cap rates by prohibiting tax preparers from brokering RALs with over a 60% annual interest rate. On the other hand, Washington State passed a weak disclosure RAL law that gutted Seattle’s better ordinance. Other states passing disclosure-only RAL laws include California, Nevada, and Oregon.
A new wave of RAL products has emerged – “pay stub loans” that are sold to consumer before the tax season begins. These pay stub loan products appear to be the response to the IRS progress, albeit delayed, in providing faster refunds. These products pose additional risk and costs to consumers, and create a “race to the bottom” by the RAL industry. In addition, pay stub loans will permit the industry to continue its drain on tax refunds and EITC dollars with usurious loans.
Risk to Consumers
In addition to their high costs, RALs can be a risky proposition. A RAL must be repaid even if the taxpayer’s refund is denied, is smaller than expected, or frozen (something that the National Taxpayer Advocate has noted happens to hundreds of thousands of taxpayers, particularly EITC recipients). If the taxpayer cannot pay back the RAL, the lender may send the account to a debt collector. The unpaid RAL will also show up as a black mark on the taxpayer’s credit record. If the taxpayer applies for a RAL or other refund financial product from a commercial preparer next year, she may find that her next year’s refund gets grabbed to repay this year’s unpaid RAL debt.