Tax-Refund Loans Bilk Low-Income People -- and Taxpayers

With the filing deadline for income taxes in less than three weeks, a lot of people are turning to professional tax preparers to assist with their returns.

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, available online at (http://www.consumerfed.org/ taxpreparers.PDF), 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.