Taxes: Death of the Refund Anticipation Loan?

The IRS just announced that, starting in 2011, it’s going to make it more difficult for tax preparation companies to provide refund anticipation loans: expensive, short-term loans for consumers who want their refund “instantly” rather than waiting a couple of weeks. These loans, often aimed at the working poor, typically come with fees that translate into annual percentage rates of 50 – 500%.

Many consumer advocates, including us, have long criticized these loans: after all, why would you pay major fees to borrow what’s essentially your own money – your tax refund? (To learn more about why we hate these loans, see this post:
Difference Between a Loan Shark and a Tax Refund Loan? Not Much.)

Historically the IRS provided tax preparation services with something called a “debt indicator” for each taxpayer – letting the preparation company know if a taxpayer’s refund was going to be seized by Uncle Sam for things like back taxes, child support or delinquent student loans. If the taxpayer’s “debt indicator” indicated the taxpayer wasn’t getting their refund, the preparer wouldn’t lend them money in the form of a refund anticipation loan.

Although the “debt indicator” was never intended to be used for this purpose – the IRS was simply trying to inform the taxpayer – by providing it the IRS was essentially pre-screening potential loan customers for tax preparation services.

Here’s the way it used to work

  • The taxpayer goes to a tax preparer and gets their taxes done.
  • The IRS receives the electronic tax return and essentially tells the preparer whether or not the customer is actually going to receive their refund, or if it’s going to be held to satisfy outstanding government debt.
  • If a refund is forthcoming, the tax preparer offers the taxpayer a refund loan. If it’s not, they don’t, since the taxpayer won’t have the money to repay it.

Here’s how it will work now, and why these loans may be dead – or at least harder to get

  • The taxpayer goes to a tax preparer and gets their taxes done.
  • The IRS receives the electronic tax return but tells the preparer nothing.
  • The tax preparer has no idea whether the taxpayer is actually getting their refund, so they’re not about to offer them a refund anticipation loan – at least, not without a lot more information.

“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 in this press release. “We are glad the IRS finally stopped letting tax preparers and banks pry into taxpayers’ records about what they owe the government.”

The Consumer Federation of America claims that in 2008, RALs skimmed $738 million from the refunds of 8.4 million American taxpayers.

The IRS agrees that the information it was providing was used to hurt poorer Americans.

“Refund anticipation loans are often targeted at lower-income taxpayers,” IRS Commissioner Doug Shulman said in its press release. “With e-file and direct deposit, these taxpayers now have other ways to quickly access their cash.”

As one might expect, the tax preparation industry isn’t so happy. Here’s what Harry W. Buckley, president and chief executive officer of Jackson Hewitt, had to say in this press release:

“This form of credit, especially important to middle and low income, often unbanked, taxpayers, may well continue to be available in our industry. However, from the taxpayers’ perspective, it will likely become harder to receive credit approval, will cost more and the amount of credit available may be limited – all negative impacts on taxpayers during this difficult economic environment, and all a direct result of the unilateral action taken by the IRS today.”

Refund anticipation loans aren’t the only type of short-term, high interest loans that are teetering on the brink of the extinction. Check out our recent story Payday Lenders Dropping Like Flies.

And when debt does become a problem, there will most likely be fewer debt settlement companies around to “help”. See our recent story New Rules Could Erase Debt Settlement Industry.

There’s no question that the lending landscape is changing in America. Some say “it’s about time.” Others say government regulators have no place disrupting free enterprise, no matter the form.

What do you say?

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    The IRS is also concerned that tax returns processed subject to a RAL may have a higher rate of error and/or fraud. Since RAL-related fees are often dependent on the amount of the expected refund, there is a “financial incentive to take improper tax return positions in order to inflate refund claims inappropriately,” according to the IRS. In 2007, Jackson Hewitt, the nation’s number two tax preparer, was accused of a “pervasive and massive series of tax fraud schemes.” The Justice Department filed lawsuits seeking to stop tax preparation services at more than 125 Jackson Hewitt stores in cities such as Chicago, Atlanta and Raleigh, claiming that tax preparers were encouraging taxpayers to fabricate expenses and use phony W-2 forms in order to boost refunds.