Tax-Refund Loans Bilk The Poor -- and Taxpayers

by Jeff Ignatius

But those services can come at a steep cost, and a recent study found that they're also steering hundreds of millions of dollars away from recipients of the Earned Income Tax Credit. That means, essentially, that the federal government (and taxpayers) are providing massive subsidies to companies such as H&R Block and Jackson Hewitt -- the country's two largest tax-preparation firms -- instead of the working poor for whom the program was intended.

The Consumer Federation of America and the National Consumer Law Center earlier this year released the report "Tax Preparers Peddle High-Priced Tax Refund Loans: Millions Skimmed from the Working Poor and the U.S. Treasury." The report details how and why low-income people spend more than a billion dollars on tax-preparation and related services.

The focus of the report is the "refund-anticipation loan" (RAL) business that allows taxpayers to file their returns electronically and receive a loan on their refund amount -- from a bank but arranged by a tax-preparation company -- in a day or two. (Taxpayers who file electronically can normally expect their refunds to be direct-deposited into their bank accounts within two weeks.)

Customers will pay an estimated $810 million in RAL fees in 2002, and for most taxpayers, that money will come out of income that was withheld from their paychecks.

But the cost is especially high for people who receive the Earned Income Tax Credit (EITC) -- the federal anti-poverty incentive that reduces the tax obligation of the working poor and supplements their earned income. According to the study, 40 percent of people who receive RALs also get the EITC.

"In 1998, half of all national EITC dollars went to working families earning less than $12,000," the report states. The study further notes that the program in 2001 provided $30 billion to more than 18 million taxpayers -- an average of more than $1,600.

In addition to paying $324 million in RAL fees each year, EITC recipients pay $670 million for tax-preparation, electronic filing, and check-cashing. In all, the report concludes, tax-preparation and RAL services take more than $1 billion a year intended for low-income taxpayers.

"This is all part of a sector of fringe financial providers that have been just booming," said Chi Chi Wu, a staff attorney with the National Consumer Law Center and a co-author of the study. Refund-anticipation loans, she said, aren't much different than "payday loans"; both have high interest rates and fees, and both appeal to people who need money quickly.

The report itemizes the costs associated with RALs: "Customers pay three fees to get a refund-anticipation loan: a fee to a commercial tax preparer for filling out the federal and state tax forms, typically $60 to $300 [the average is $85]; a fee for the electronic filing, with the average being $40; and a loan fee to the lender, typically set on a sliding scale based on the amount of the expected refund. Typical loan fees range from $29 to $89, but can be as high as half the refund. ... The total amount of the three fees can range from $129 to $429." The average EITC recipient will pay approximately $200 in fees and interest on tax-preparation and an RAL, which represents more than 12 percent of the average benefit.

Like many short-term loans targeting the working poor, the interest and fees charged on RALs don't seem bad because they aren't generally disclosed in percentage terms. While interest and fees of $29 to $89 might seem reasonable, these loans -- with a term of approximately 10 days -- have annual interest rates that range from 67 to 774 percent. Tax-preparation services get around state laws capping interest rates by partnering with federally chartered banks, because the federal government has no usury laws.

H&R Block and Jackson Hewitt together account for nearly half of all RALs. According to the report, H&R Block made $68 million in profits on RALs alone in 2001.

One reason these refund-anticipation-loan services have largely operated without media or government scrutiny is that -- to some degree -- the people who are paying high fees for these services don't see themselves as getting ripped off; income-tax refunds are often viewed as free cash, and the EITC is not even a "refund" but a subsidy from the federal government. "So many people look at this as 'found' money," Wu said.

Furthmore, said Consumer Federation of America Director of Consumer Protection Jean Ann Fox, RALs target a small percentage of the population and are only a problem during tax season. "There really wasn't a lot written" about RALs before the two consumer groups drafted their report, she said.

It would be easy to simply fault H&R Block and Jackson Hewitt for exploiting low-income people, but the issue is more complex than that; Wu called it "systemic." A variety of factors contribute to the problem:

• The Earned Income Tax Credit is complicated, and many low-income people need help preparing their returns to claim it correctly.

• Because many people who receive the Earned Income Tax Credit live paycheck-to-paycheck, they don't have the money up-front to pay for tax-preparation services. If they need professional help to prepare their taxes, a refund-anticipation loan is a relatively easy way to pay for it, because preparation fees come out of the loan amount.

• Outside of big cities, there are few places that offer free tax- preparation service. The Quad Cities offer some volunteer income-tax assistance through Project Now, for example, but the program does not allow people to file returns electronically. That means EITC recipients who use the service have to wait months for their money. "Most people wanted to go where they could file electronically" and get their money sooner, said one Project Now representative.

• To get a refund quickly -- within two weeks -- taxpayers need to file their returns electronically and have a bank account. The "unbanked" -- more than 10 million households fall into the category -- can file paper returns, but because they frequently need the money quickly, they opt for refund-anticipation loans.

• Congress has established a goal of having 80 percent of tax returns filed electronically by 2007. That gives the IRS an incentive to increase e-filing any way it can, and provides a disincentive to crack down on companies that might be exploiting low-income people who without RALs would probably file paper returns.

• Many people don't realize that tax-preparation services that offer refunds in a day or two are actually providing loans on the anticipated amount of the refund. "An H&R Block study found that many consumers would decline to participate in the 'Rapid Refund' service if they knew it was a loan," the report said. "Company training manuals instruct staff not to provide full information, but to limit affirmative disclosures to items 'most important to the client,' such as when the check would be available, the amount of the fees, and whether the fees would be withheld from the check."

In that environment, Fox said, customers are getting suckered: "If you don't know it's a loan, your don't have your credit defenses up." In addition to paying high fees, customers are also liable for the amount of the loan if the refund ends up being less than expected.

Denise Sposato, a spokesperson for H&R Block, said that "most of the report is based on opinions." When asked to counter the factual claims of the report, Sposato cited two items: Customers are given options that do not involve loans, and the word "loan" is listed 30 times on documents that customers sign.

But products that do not involve loans take longer (eight to 10 days) and still have a significant cost attached to them -- a $24.95 flat fee.

"We're not in the loan business," Sposato concluded. "We offer these because our customers demand it."

A spokesperson for Jackson Hewitt did not respond to a phone message requesting comment.

Wu suggested the easiest way to ensure that taxpayers don't get ripped off by RALs would be for Congress to cap annual percentage rates at the state usury limit or 36 percent.

But the financial-services sector would fight such regulations, and Congress to this point has shown little interest in the issue. Other suggestions from the report include increasing free income-tax- preparation services, making the EITC paperwork simpler, and boosting efforts to establish bank accounts for people without them.

Fox said that education could play a big role, too. "The first line of defense is to warn consumers," she said. "If you can wait, ... you get all your tax refund. ... If you get your money in a day or two, it's not a refund. It's a loan."