Information about Refund Anticipation Loan

A (Tax) Refund Anticipation Loan (RAL) is a high interest rate short-term loan secured by a taxpayer’s expected tax refund.

United States

In the United States, the taxpayer commonly applies for the loan through a paid tax preparation firm. The tax preparation firm receives a fee for each loan originated, but in the United States the Internal Revenue Service rules prohibit basing this fee on the amount of the expected refund. Only the banks through which the loan is made are allowed to charge interest or finance charges.

According to the National Consumer Law Center, 12 million taxpayers used an RAL in 2004.^[1] With e-filing, tax refunds can be direct-deposited into the taxpayer's bank account within two weeks, rendering RALs less attractive to some.

Controversy

Despite their commonplace nature, RALs are controversial. 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. Processing of a tax return can take anywhere from one week to a month and a half. Fees for these loans are in line with industry wide standards for non-secured loans. Supporters of RALs may also contend that many individuals are not entirely truthful when completing their taxes, and that banks take a great risk relying on the word of an individual that his or her tax refund will be received in the amount claimed. Specifically, if a taxpayer provides false information when asked about outstanding federal or state taxes, past due child support, delinquent student loans this can cause the refund anticipation loan to be issued, but the tax refund is never issued by IRS as it is seized to pay debts.

Opponents of RALs such 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 think the wait for their refund is longer than it really is, who do not realize they are making a loan, who do not understand the high interest rates charged by the loan (often exceeding 100% APR), and who do not actually need the funds immediately. An empirical study at Georgetown University found that a large fraction of RAL customers appear to use limited decision processes.^[2]

Even cash advances on credit cards have much more attractive long term rates than RALs. For example, a representative RAL is a ten-day $3,000 refund anticipation loan with a loan fee of $89-$170, resulting in an annualized interest rate between 108% and 202%. However, over the 10 day loan period credit card cash advances are comparable in cost to RALs because of the upfront percentage fees added when consumers take such advances. RAL fees are generally calculated as 3% of the loan, while credit card advance fees vary from 2-5% of the amount advanced, making them clearly comparable. It also bears mention that credit cards with $3,000 limits are generally not available to consumers who seek RALs because of their low incomes and generally incredibly poor credit histories.

More than half of all RAL consumers are low-income recipients of the Earned Income Tax Credit (EITC), despite the fact that EITC recipients constitute only 15% of all taxpayers.

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. The interest rates charged in that business exceed 500%, including fees (this includes the tax preparation fee, which is unrelated to the RAL, but included per California law). Lockyer said the company falsely portrays 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.^[3]

Despite the litigation cited above, the vast majority of RALs are legally made and several dozen lawsuits are dismissed against each of the major tax preparation firms each year.

In December 2006, firms like Jackson Hewitt and H&R Block were making refund anticipation loans as early as October 15, 2006, aimed at providing money to individuals for Christmas. These were RALs and encouraged (but did not require) the individuals to return to file their taxes 4-5 months later with that tax company.

Because of this pressure HSBC which backs H&R Block and the largest provider of RALs, has announced it will be withdrawing from the pre tax season industry; HSBC does intend to continue tax season refund anticipation loans. Santa Barbara Bank and Trust(a division of Pacific Capital Bank) and Chase, the second and third largest providers of RALs, have also discontinued refund loans outside of tax season, though both intend to continue making RALs during tax season. The withdrawal of the three major banks from the preseason loan industry has effectively destroyed the product and they are not being offered after April 30, 2007 by any of the three major tax preparation companies (H&R Block, Jackson Hewitt, and Liberty Tax).

Canada

In Canada the process is referred to as "tax rebate discounting", where a tax preparation firm purchases the right to the anticipated refund in exchange for a percentage of the refund amount. Canada Revenue Agency rules establish the maximum discounting fee as 15% of the first 300 C$ and 5% of any remaining amount. No other fees for preparation or filing the return are permitted. This commonly works out to a high effective interest rate, although in a small number of cases the discount may be comparable or even less than an ordinary tax return preparation fee.

IRS regulations contained in IRS Circular 230 specifically prevent the implementation of a similar system in the US as tax preparers are not allowed to charge fees as a percentage of a client's refund. Preparer fees (not to be confused with bank fees to issue the loan) can be based on hourly rates, form/schedule charges, both, or any other reasonable method, but not a percentage of refund.

References

External links

• Consumer Use of Tax Refund Anticipation Loans, Gregory Elliehausen, McDonough School of Business, Georgetown University, April 2005.
• National Consumer Law Center: Refund Anticipation Loans
• E-filing can make high-fee loans unnecessary, MSNBC, 2006-02-15
• Calif. sues H&R Block over tax refund loans, MSNBC, 2006-02-15