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Financial Well Being

March 2008

“Quick Tax Refunds” What’s Real? What’s Really a Loan?

You’ve seen similar ads and posters from income tax preparation services:

Quick Income Tax Refunds
Rapid Refunds
Instant Money from Tax Refunds
Get Your Tax Refund Money Today

Some check cashing services are also featuring similar promotions. And what about auto dealerships that urge you to use your refund for a down payment on a new vehicle or retail establishments who want you to put that refund toward new furniture, appliances, or entertainment centers. To help you do that, they’ll be happy to help you prepare and electronically file your taxes.

Such offers sound great, don’t they? After all who likes to prepare taxes? And who wouldn’t want their refund as soon as possible. The problem with such quick refunds is that they are really loans—and very high interest rate loans, too. How high? Typical Refund Anticipation Loans (RALs), as they are formally called, have effective Annual Percentage Rates (APRs) of from 50% to over 500%; the APR can zoom to over 1,200% if application fees are charged, as many lenders do. These facts com from the 2008 report on RALs from the Consumer Federation of America (CFA) and the National Consumer Law Center (NCLC).

What’s the problem with Refund Anticipation Loans?

Actually there are several problems according to studies from a variety of consumer groups such as Consumer Union, CFA and NCLC as well as research groups such as the Brookings Institution. Here are several major points.

Promotion and presentation of quick tax refund loans are often misleading. Most promotions emphasize the speed with which you’ll get your money not the fact that what you’re getting is a loan. Studies show that many consumers never realize the check or cash they’ve gotten is a loan not their refund. Even where companies state clearly that their product is a loan, they may not mention that fact until after a consumer has signed the RAL application. In other cases, paperwork may bury the loan information in fine print, or a customer may be given a stack of papers and directed to sign various lines (including the loan agreement) without looking fully at the papers.
High costs characterize RALs. An exorbitant interest rate is the first high cost. Loan fees that typically range from about $30 to $125 may seem small until you realize that they translate into triple digit APRs for what’s typically an 8 or 9 day loan. In addition, many tax preparers or other companies offering RALs charge application fees and fees for "refund accounts" for taxpayers who don't have bank or credit union accounts—these fees can more than double the effective interest rates. Many taxpayers using these fee services would probably qualify for the IRS’s free electronic filing program (more about that below). Total cost to nearly 9 million RAL borrowers according to CFA/NCLC figures for 2006 (2005 tax year): About $900 million for loan fees and over $90 million for other fees. These figures are down from the previous year, but still account for almost 1 billion dollars. In addition to loan-related fees, most customers also pay fees for tax preparation service. The average tax preparation fee is about $150; actual fees may be lower or much higher.
A refund loan doesn’t actually save much time. Getting a check in two days seems to be the time frame featured by most companies offering RALs (and some are offering a "check today" for a higher fee); these companies typically also prepare the tax return and file it electronically. The IRS notes that if the taxpayer files a return electronically and has the refund direct deposited into a bank account that the taxpayer can expect the refund usually within 10 days. Costs that can range into the hundreds of dollars are really steep for what amounts to an eight-day or nine-day loan.
Taxpayers are still responsible for the full loan even if the IRS disallows part or all of the refund. If for any reason (such as a mistake made by taxpayer or tax preparer, a disallowed deduction or unpaid student loans or child support), the IRS doesn’t pay the total refund anticipated or perhaps doesn’t pay any refund, the borrower of the RAL is responsible for the whole loan. If you can’t pay it back, you can usually expect harassing collection tactics and damaged credit ratings.
Companies offering RALs typically target low and moderate income taxpayers who are least able to afford the costs. According to the NCLC/CFA 2005 report, over half of customers who got refund loans were recipients of Earned Income Tax Credit (EITC), a government anti-poverty program for low-income families and individuals that’s paid out as a tax refund. Because such taxpayers often need help to prepare the complicated application forms for the EITC and may not have upfront the necessary tax preparation fee of $50 and up (sometimes way up), they are easy targets for RALs. Many such consumers also do not have bank accounts which leaves them vulnerable for additional fees to have a “dummy account” set up in their name for direct deposit or fees for a stored value card (a kind of prepaid debit card). An earlier report from the Brookings Institution estimated that $1.75 billion in EITC funds went to pay for “tax preparation, electronic filing and high cost refund loans.” They also found that half the $30 billion of EITC claimed in 1999 was paid out in RALs.
Some companies use creative ways to jack up fees. In one case reported by CFA and NCLC, in addition to all the fees for preparing and filing the return, the taxpayer received his loan as a debit card—only to find out that he had to pay a fee of $29 every time he used the card to withdraw money. Since he could only withdraw $400 at a time, think how much he paid to access the total amount of his refund loan.

What other options offer quick access to tax refunds?

You have several options that can help speed your refund money to you.

File your return electronically and have your refund direct deposited to your credit union or bank account. A number of software companies provide software that helps you prepare your federal and state tax returns on your computer and file them electronically over the Internet. If you don’t own a computer (or even if you do), they also offer Web-based services where you can open a private file and prepare your tax return from any computer to which you have access. The fee for the software and filing is typically small (and many companies typically offer some kind of rebate further decreasing the cost). If you qualify for the IRS Free File program, you need not buy software and can file free on the Internet. Even if you are among the 60% of Americans who feel they need help preparing their returns, try using the IRS Free File program. It is similar to using a commercial tax preparer.

Use the IRS Free File Program, if you qualify. Since tax year 2002, the IRS has partnered with private companies to provide free online filing through the Free File Program. Eligibility requirements vary from company to company, and include income level, age, military status, and state of residence, depending on the company. In 2008 (for 2007 taxes) Adjusted Gross Incomes of under $54,000 will typically qualify for several programs. You can check to see if you qualify by previewing all the participating companies requirements on the IRS website or using "Guide Me To A Company!" to see which you qualify for. To file your return through the Free File program, you must start on the IRS website. A caution: Consumer groups warn consumers to be aware that since they are dealing with commercial companies that the companies may offer fee-based services that the consumer is under no obligation to take. The rules, however, prevent the companies from advertising RALs.

Take advantage of free tax preparation help. In communities throughout the country the IRS-sponsored Volunteer Income Tax Assistance Program is available to lower and moderate income taxpayers as is the Tax Counseling for the Elderly Program (TCE). Call toll-free 1-800-829-1040 to locate a program near you. The AARP provides AARP Tax-Aide, a free online tax counseling program for the elderly from February 1 to April 15 each year. You can also call your public library which often has information about local tax help preparation. If there is a branch of the IRS in your city, they also provide free help to taxpayers.

Adjust your withholding—don’t use the IRS as a no-interest savings account. If your return comes close to the average of $2,255 (or even if it’s less), then you can put that money to work for you sooner by adjusting your tax withholding. If you take that money—it would be about $188 a month in our example—and deposit it in your credit union savings account or other savings fund then at the end of the year you would have immediate access to your money and it would have earned some interest. You’d also have access to it anytime during the year you needed it. If you fear you don’t have the discipline to voluntarily save that amount out of your paycheck each month, why not see if your employer has plan that allows you to have a certain portion of your check deposited directly to your savings account.

What about filing state taxes?

Some states have taxpayer-friendly programs in place. In Wisconsin you may file your state taxes online or over the phone for free. The Wisconsin Department Revenue website has all the details. For all states, the software companies that offer online preparation and e-filing of federal taxes also provide state programs for modest fees. Again, stay alert for fee-based services that you aren’t obligated to take.

For more information

The Wisconsin Department of Revenue has prepared this FAQ on RALs.

The following reports provide a detailed discussion of RALs, including many facts, figures, and illustrative case examples. All can be downloaded in a “pdf” format that you will need Acrobat Reader to access. Click here to download Acrobat Reader for free if you do not have it on your computer.

Positive Improvements for Tax Refund Loans, But Consumers Still Warned to Avoid Them—2008 Report prepared by Consumer Federation of America and the National Consumer Law Center

Down But Not Gone: Quick Tax Refund Loans Continue to Gouge Taxpayers—2007 Report prepared by Consumer Federation of America and the National Consumer Law Center

The High Cost of Quick Tax Money: Tax Preparation, “Instant Refund” Loans, and Check Cashing Fees Target the Working Poor—2003 report prepared by Consumer Federation of American and the National Consumer Law Center.

The Price of Paying Taxes: How Tax Preparation and Refund Loan Fees Erode the Benefits of the EITC—2002 report by Alan Berube, Anne Kim et al, from the Brookings Institution and the Progressive Policy Institute.

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