Refund Anticipation Loans

“The trade of the petty usurer is hated with most reason: it makes a profit from currency itself, instead of making it from the process which currency was meant to serve. Their common characteristic is obviously their sordid avarice.” — Aristotle

If you have your income tax return filed at a paid professional tax preparation service, and your tax return shows a refund; you will probably be offered a refund anticipation loan. Just say “no.”

Refund anticipation loans (“RALs”) are extremely high-cost bank loans secured by the taxpayer’s expected refund — loans that last until the actual IRS refund repays the loan. RALs are aggressively marketed by income-tax preparation companies. They advertise “Instant Refunds” or “Quick Cash” for their cash-strapped customers who need money in a hurry, and disguise the fact that they are selling advance loans on anticipated tax refunds.

How does a RAL work? Additional fees are charged by the tax preparation service to arrange a short-term bank loan for the taxpayer and to open a bank account. The bank who makes the loan charges finance charges. Your refund is paid to the bank to pay off the loan.

But you can get your refund almost as quickly without any fees or interest charges. If you e-file your taxes with the IRS and have your money deposited directly into your bank account, you can generally get your refund in fewer than ten days. There’s no fee for e-filing, and you don’t have to pay any interest. The IRS began accepting e-filed tax returns for 2009 on January 15.

Kimberly Lankford reported in Kiplinger’s Personal Finance that the effective annual percentage rate for refund-anticipation loans can range from about 50% (for a $10,000 loan) up to nearly 500% (for a $300 loan) when you include interest charges and refund account fees.

Here is an example from Kelley Philips Erb’s article for Taxpayer is expecting a refund of about $800. She goes to a franchise tax preparation service where she is charged $200 for return preparation. They offer her a RAL, telling her that without it she could wait up to 12 weeks to get her refund. (This is not true.) She paid a $75 processing fee, a $60 service fee, and $50 in bank fees. Combined with the $200 preparation fee, she paid nearly $385. Instead of getting $800 in 20 days, she got about $400 the next day. That’s crazy.

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.

Opponents of RALs say 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), and who do not actually need the funds immediately. The Consumer Federation of America and the National Consumer Law Center, say that Refund Anticipation Loans are controversial because, like payday loans, RALs are high-profit, low-risk loans marketed to the working poor.

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 Earned Income Tax Credit.
In 2006, the California Attorney General sued H&R Block over its refund anticipation loan business, citing effective annualized interest rates that exceeded 500%, including fees. The suit claimed H&R Block falsely portrayed the nature of the loans, advertising “cash, cold, green, in your hand, out the door.”

The IRS is also concerned that RALs are linked to tax fraud. Since the fees for the RAL are linked to the amount of the refund, preparers are incented to inflate refund claims inappropriately. A 2006 Government Accountability Office investigation found inflated refunds for 6 out of 19 paid preparers they tested. Repeated sanctions were imposed against Jackson Hewitt for engaging in deceptive, misleading and even criminal conduct, including a $5 million settlement with the California Attorney General over false and deceptive marketing of RALs and a 2007 enforcement action by the U.S. Department of Justice against five Hewitt franchisees for engaging in a tax fraud schemes that falsely claimed $70 million in refunds.

If you decide to go ahead with a RAL, make sure you read the fine print and understand exactly what your are paying for what service. The loan is a private arrangement. It is not offered by or through the IRS. Be careful.