A refund anticipation loan (RAL) is a short-term consumer loan secured by a taxpayer’s expected tax refund, and designed to offer customers quicker access to funds than waiting for their tax refund. A somewhat similar process in Canada is termed tax rebate discounting.
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In the United States, taxpayers often apply for a refund anticipation loan through a paid professional tax preparation service, where a fee is typically charged for the preparation of the tax return. In the United States the Internal Revenue Service rules prohibit basing this fee on the amount of the expected refund. An additional fee is usually charged by the service for originating a bank product and establishing a short-term bank account. By law this fee must be the same on both loan and non-loan bank products, and in 2004 the average fee was $32.[1] The bank through which the loan is made charges finance charges.
According to the National Consumer Law Center, 12 million taxpayers used an RAL in 2004.[2] With e-filing and IRS partnerships that help consumers e-file for free, U.S. taxpayers can receive their tax refunds within three weeks and as quickly as ten to fourteen days if they choose to receive their refund via direct-deposit. This has rendered RALs less attractive to some.[3]
RALs began in the 1980s when the IRS introduced electronic filing as a way to decrease its cost of operation.
A tax preparer would, within 24 hours of submission, receive from the IRS confirmation that the submission was free of mathematical errors, and that the filer had no liens or delinquent federal student loans. This meant that there was good chance that the IRS would pay the refund within weeks, barring fraudulent income reporting. At that point the preparer would issue the filer a check for the amount of the expected refund minus a commission. In 1995, the New York Times reported that Beneficial's $30 electronic filing fee and $59 loan fee amounted to a 250 percent APR on a refund of $1,000.[4]
By the early 1990s, exploitation of the system began; filers misreported their income to inflate their refund. As a result of this, and also to discourage filers from this rather uneconomical offer, in 1994 the IRS stopped providing tax preparers a confirmation that a deposit would take place for a certain amount and that it would begin sending refunds directly to taxpayers instead of banks that made the loan,[4] but not having the desired effects, the confirmations were re-instated the following year.
According to the Consumer Federation of America and the National Consumer Law Center, RALs are controversial because, like payday loans and title loans, RALs are high-profit, low-risk loans marketed toward the working poor. A 2006 study by the NCLC and the Consumer Federation of America found that "Based upon the prices for RALs in 2006, a consumer can expect to pay about $100 in order to get a RAL for the average refund of about $2,150 from a commercial tax preparation chain this year."[5]
Supporters of the practice say the loans allow people access to funds immediately in cases of an emergency such as overdue medical bills, credit payments, and other debts while they wait for the IRS to process their income tax return. Many taxpayers can file form W-4 to adjust their withholdings to the correct level. When this is possible, a taxpayer can hold on to all cash that would be offered by an RAL without paying any fee, thereby making the cash available at any time.[6] However, in the case of some refundable credits such as the earned income credit, a large refund can be due even if no withholding is made (and even if the maximum advanced earned income credit is paid). In 2006, 63 percent of RAL consumers were EITC recipients.[7]
Supporters of RALs may contend that the fees are justified by the high risk of default associated with these short-term loans, since there is a possibility that the IRS will issue a reduced refund or none at all, depending on whether the taxpayer followed the correct procedures in calculating his or her tax. The question remains whether consumers in a free-market are better able to determine their need for various high cost financial products including pawn shops, check cashers, and RALs or whether people need protection from these products by the government.
Opponents of RALs, like as the National Consumer Law Center, argue that the profit motive of the lender results in RALs being issued too often to low-income individuals who are made to believe the wait for their refund is longer than it really is, who do not realize they are taking a loan, do not understand the high interest rates charged by the loan (often exceeding 100% APR until the last two tax filing seasons), and who do not actually need the funds immediately.[8] An empirical study at Georgetown University found that a large percentage of RAL customers appear to use limited decision processes. In recent years several of the banks who provide RAL loans have lowered the annualized interest (APR) on these short-term loans to under 36%.
More than half of all RAL consumers are low-income recipients of the Earned Income Tax Credit (EITC); in 2006, the NCLC estimates RAL loans cost RAL recipients $1.24 billion (USD) in loan fees and another $360 million in administrative, electronic filing and application fees.[9]
In 2002, H&R Block settled a lawsuit brought by the New York City Department of Consumer Affairs for predatory lending practices with regard to RALs and the EITC.
In 2003, the Illinois Attorney General issued a detailed warning to taxpayers about such loans.
On February 15, 2006, the California Attorney General, Bill Lockyer, sued H&R Block over its refund anticipation loan business,[10] citing interest rates exceeded 500%, including fees (which included the tax preparation fee, which is unrelated to the RAL, but included per California law). Lockyer said the company falsely portrayed the nature of the loans, advertising "cash, cold, green, in your hand, out the door."
In May 2005, a federal judge in Chicago rejected a $360 million settlement as inadequate.[10]
Under the National Bank Act, national banks and their agents who make RALs are broadly excluded from regulating RALs. The only actions that states bring against RAL providers involve allegations of falsely portraying the circumstances of the loan, or fraud. A RAL is a legal loan beyond the scope of the ability of any state agency or state legislature to regulate as a matter of federal law.
RALs are within the legislative scope of the United States Congress and to a considerably lesser extent the regulatory authority of the IRS; however, Congress has not demonstrated serious interest in this subject and while the IRS did issue a "Advance Notice of Proposed Rulemaking" in January 2008 that would prevent the tax preparer from sharing tax return data with the lending bank, the advance notice was very poorly received on Capital Hill because of implications that it would have had for other types of loans where tax returns, tax return data, and CPA statements are used as part of a loan decision package.
As part of applying for the loan, the client is also directing his or her refund to the loan-issuing bank. Cross-collection occurs when the bank then uses this occasion to collect debt owed another bank. As the IRS Taxpayer Advocate described the practice in 2006: “ . . . if a taxpayer owes money on a defaulted RAL to Bank A and subsequently attempts to buy another RAL from Bank B, Bank B is authorized to collect the outstanding debt from the RAL proceeds, transmit the funds to Bank A, and provide the remaining balance to taxpayer . . . ” [11] This practice is often not adequately disclosed to the tax preparation client. As a lawsuit filing against H&R Block by the California Attorney General in Feb. 2006 stated, “ . . . H&R Block does not adequately tell such customers about any alleged debts, or that when they sign the new RAL application, they agree to automatic debt collection - including collection on alleged RAL-related debts from other tax preparers or banks. These applications are denied, and the customer's anticipated refund is used to pay off the debt, plus a fee. . . ”[12]
On Aug. 5, 2010, the IRS announced that for the upcoming 2011 tax filing season, the agency would no longer be providing preparers and associated financial institutions with the “debt indicator” (a one-letter code that discloses whether or not the taxpayer owes back taxes and whether or not the taxpayer owes federally collected obligations such as child support, student loans, etc.).[13][14] The result of this has pushed most tax preparers other than national chains out of the RAL business, and many smaller preparers have simply gone out of business due to losing that chunk of their business. All but two banks have dropped out of the RAL programs.
Taxpayers themselves will continue to have access to information about their refund through the “Where’s My Refund?” feature at the irs.gov website.[14]
In the same news release, the IRS stated it was exploring ways to allow filers to directly split off part of the refund to pay for professional tax preparation, potentially starting in January 2012. The IRS is asking for input from filers, consumer advocates, and those in the tax preparation community regarding whether this would be cost-effective.[14]
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