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Refund Anticipation Loans (RALs) are loans made by banks, secured by and repaid directly from the proceeds of the borrower’s tax refund. These loans are usually repaid when the actual IRS refund is received, a period of about 7-14 days. That’s the first indicator of just how unnecessary most RALs are: Most taxpayers could have their refund in two weeks or less even without the loan.
But for poor families, the tax refund check is often the largest single sum of money they receive during the year. They may need money quickly, and RALs deliver hard cash sometimes in the same day or even within an hour of filing their tax returns.
In their heyday more than 60 percent of all RALs were for workers who claimed the EITC.1 But they are costly.
RALs cost from about $30 to over $125 in loan fees. Some tax preparers also charge a separate fee, often called an “application” or “document processing” fee, up to $40.
The smaller the RAL, the higher the effective interest rate. The APR (Annual Percentage Rate) for a 10-day loan ranges from about 40 percent for a loan of $10,000 to 500 percent for a loan of $300. Most EITC loans are less than $500.
If application fees are included in the calculation, the effective APR on an EITC loan can be over 1,100 percent.2
There is a name for interest rates like these: USURY. Usury is illegal in most states, but thanks to a 1978 Supreme Court decision, national banks were exempt from usury laws when doing business outside their home state.3 This loophole was closed in Obama’s first term, and as a result, between 2009 and 2012 banks exited the RAL market either voluntarily or because they were forced out by federal regulators.4
IRS data show a collapse
in the RAL market, with applications falling from 9.9 million in 2008 to
100,000 in 2013:
But fraud always finds a way. While the large tax preparation chains (H&R Block, Jackson Hewitt, and Liberty Tax) no longer market RALs to their customers, there are literally thousands of small or solo independent preparers who do. These tax entrepreneurs range from licensed professionals like attorneys and CPAs, to businesses that deal in other lines entirely.
“Among the last group,” notes a 2014 report by the National Consumer Law Center, “…there is a segment that is highly problematic—the fringe preparer. Fringe preparers include businesses that are historically associated with the exploitation of consumers, such as payday loan stores, check cashers, and used car dealers. Some retailers, such as jewelry and furniture stores, also act as fringe tax preparers. Many of these preparers encourage clients to use their tax refunds for large purchases.”5
For states, the integrity of the federal credit is crucial because their own EITC refunds are usually set as a fixed percentage of the federal EITC amount. Many conduct surreptitious “mystery shopping” tests in which a faux customer gives financial information to a tax preparer.
The results are alarming.
Alabama conducted mystery shopper tests of 13 tax preparers. Testers described themselves to preparers as parents with one or two children who lived with them less than six months of the year, which would make them ineligible for the EITC. Nevertheless, 11 of the 13 preparers incorrectly claimed the EITC. In addition, 10 of them did not report income from other jobs such as babysitting; 9 did not report interest income; and 11 tax preparers allowed testers to claim “head of household” status without being qualified for it.
None of the Alabama testers qualified for refunds, yet each preparer calculated a refund ranging from $65 to $6,247. Five preparers calculated a refund of $6,247 for a taxpayer who actually owed $112 to the IRS. These five preparers included a fringe preparer (a finance company), a Mo’ Money Taxes outlet, and three other independent preparers.6
In 2010, consumer groups conducted 19 mystery shopper tests in Arkansas, New York City, and Durham, North Carolina. At least 6 of the 19 testers, or over 30 percent, were victims of incompetent tax preparation or outright fraud.
A very disturbing example came from a tester in New York City who described how the preparer, when realizing the tester would receive only a $1,000 federal EITC refund and would owe state taxes, began making up deductions:
[The tester] reported that the tax preparer tried to entice her to commit tax fraud by showing her how much her federal refund would increase if she took deductions in excess of the standard deduction. [The tester] does not attend church, but the tax preparer included a $2,000 church donation. The preparer also deducted the cost of work clothes and laundry, then showed [the tester] that her federal refund would increase to $3,000 from about $1,000. The preparer also tried to convince [the tester] to make up a dependent as she does not have any—showing her that her refund would go up to $5,000 if she did so. The preparer also tried to qualify her for EITC even though she is not eligible… 7
An incorrectly prepared tax return can lead to dire economic consequences or even criminal sanctions. This is especially true for EITC recipients, of whom over 60 percent—or 16 million families—pay for tax preparation.
Yet in most states there is no regulation of these “fringe” private tax preparers. There are no minimum educational, training, competency, or other standards for the businesses that could determine the EITC applicant’s financial fate for the coming year. While some tax preparers are licensed CPAs, the vast majority do not have such qualifications.
In 46 states, there are more regulatory
requirements for hairdressers than tax preparers.
Unintended consequences, or a Liberal Power Grab?
In retrospect, the government’s decision to force large commercial tax preparers out of the RAL market was a mistake. RAL fraud, abuse, and costs are more egregious today than when the large tax preparation franchises were allowed to partner with banks.
Large commercial tax preparers flourish because they provide a level of convenience, speed, and expertise that “fringe” preparers cannot match. Competition among the H&R Blocks of the world significantly reduced preparation fees and RAL interest costs. All U.S. taxpayers, especially those who receive EITC, are worse off now that the large commercial tax preparers are prohibited from making RAL loans.
By pushing commercial companies out of the RAL business, the government increased the clout of liberal activist groups that offer free tax preparation service. Foremost among them: The Center on Budget and Policy Priorities (CBPP).
As discussed in the next section, CBPP has harnessed a large network of community organizations, schools, state and local governments, labor unions, and advocacy groups to its EITC outreach campaign. Members receive a “Tax Credit Outreach Campaign Kit”—updated annually—outlining CBPP’s strategy for promoting the credit and linking eligible workers to free tax filing assistance. Flyers in Hmong, Tagalog, and eighteen other languages—designed to hook immigrants into the EITC culture—are prominent features.8
In negotiations surrounding the Trump tax cut, CBPP has lobbied for expanding eligibility and increasing EITC payment amounts. The demise of the commercial RAL market has increased their leverage. ■
3. Zach Carter, Democrats May Deny It, But This Bill Is a Handout To Payday Lenders, Huffington Post. November 16, 2017.
Chi Chi Wu,
Risks: Taxpayers Face Perils From Unregulated Preparers, Lack of Fee
Tax Time Financial Products,
National Consumer Law Center, March 2016.
5. The National Consumer Law Center, Riddled Returns: How Errors and Fraud by Paid Tax Preparers Put Consumers at Risk, and What States Can Do, Executive Summary, March 2014, p. 4.
6. Ibid., p.12.
7. National Consumer Law Center, March 2014, p.7.
8. Center on Budget and Policy Priorities, 2011 Tax Credit Outreach Kit. http://eitcoutreach.org/category/outreach-tools