Refund anticipation loan
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Refund anticipation loan (RAL) is a short-term consumer loan in the United States provided by a third party against an expected tax refund for the duration it takes the tax authority to pay the refund. The loan term was usually about two to three weeks, related to the time it took the U.S. Internal Revenue Service to deposit refunds in electronic accounts. The loans were designed to make the refund available in as little as 24 hours. They were secured by a taxpayer’s expected tax refund, and designed to offer customers quicker access to funds.
The costs to the borrower could be significant compared to other lending and some consumer organizations warned consumers of the risk involved in this type of loan. They are a largely discontinued financial product and beginning with the 2013 tax filing season, they have been largely replaced with the similar refund anticipation checks (RAC), as well as a hodge podge of other financial products.
RACs are temporary accounts which wait for the client's IRS tax refund, and which also provides a way for the client to pay for tax preparation out of the refund. Both financial products have similar fees and similar risks of third-party bank "cross-collection".
- 1 United States
- 2 History
- 3 Controversy
- 4 State crackdown on refund loans
- 5 Third-party cross-collection of bank debt ("previous debt") for both RALs and RACs
- 6 Jan. 2011: IRS will not be providing “debt indicator”
- 7 Jan. 2013: Major U.S. banks stop offering RALs
- 8 See also
- 9 References
- 10 Articles
- 11 External links
In the United States prior to the 2013 tax filing season, taxpayers could 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 was usually charged for the services of 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. The bank through which the loan was made charges finance charges.
According to the National Consumer Law Center, 12 million taxpayers used a RAL in 2004. With e-filing and IRS partnerships that help consumers e-file for free, U.S. taxpayers can generally receive their tax refunds within three weeks and sometimes as quickly as ten to fourteen days if they choose to receive their refund via direct deposit. This rendered RALs less attractive to some.
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.
Exploitation of the system had begun by the early 1990s; 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, but not having the desired effects, the confirmations were re-instated the following year.
||This article's Criticism or Controversy section may compromise the article's neutral point of view of the subject. (October 2008)|
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".
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. However, in the case of some refundable credits such as the earned income tax credit (EITC), a large refund can be due even if no withholding is made. In 2006, 63 percent of RAL consumers were EITC recipients.
Supporters of RALs may contend that the fees are justified by the high default risk 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 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. 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 in loan fees and another $360 million in administrative, electronic filing and application fees.
State crackdown on refund loans
On February 15, 2006, California Attorney General Bill Lockyer sued H&R Block over its refund anticipation loan business, 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".
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 Capitol Hill due to potential ramifications for other types of loans where tax returns, tax return data, and CPA statements are used as part of a loan decision package.
Third-party cross-collection of bank debt ("previous debt") for both RALs and RACs
As part of applying for both financial products, the client is directing his or her refund to the account-issuing bank. Cross-collection occurs in cases where the bank 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”. It is somewhat unclear how broad is the type of debt for which banks cross-collect. 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 February 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”. Tax prep firms often vaguely refer to this practice merely as "previous debt".
This risk exists even if the client is only using the RAC account for purposes of taking the tax preparation fees out of the refund.
Jan. 2011: IRS will not be providing “debt indicator”
On August 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.). 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.
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, possibly 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.
Jan. 2013: Major U.S. banks stop offering RALs
Beginning with the 2013 tax season, major U.S. banks will no longer be offering RALs. They will instead be offering the similar financial products of RACs, which are not loans but are rather temporary accounts which sit empty waiting for the client's IRS refund.
Some smaller banks and "sketchy lenders" operators may still be offering RALs.
A March 2013 CNNMoney article found that tax prep firms are offering a hodge podge of loan products for the 2013 tax filing season. For example, the website for Jackson Hewitt advertises credit lines ranging from $200 to $1,000, which come with a 35% interest rate, a $6.25 monthly fee and a fee of 3% or $10 every time the credit line is accessed. AIT Financial Group launched a product this year that potentially pays $600 to someone expecting a refund of $700 to $725 and potentially pays $1,250 for a $1,500 to $1,600 refund. Presumably, just like with previous RALs, whatever these financial products might be called, they are in fact loan applications, with the bank approving some and not approving others. This CNNMoney article further states, "The NCLC National Consumer Law Center also found that some shady tax preparers are even offering tax refund loans to lure taxpayers into their offices, but have no intention of lending them the money".
Presumably, many of the account fees remain the same, as well as the risk of third-party bank "cross-collection".
- Payday loan, another type of low-principal, high-interest short term loan
- Alternative financial services
- Republic Bank & Trust Company
- "Refund Anticipation Loans Come With Risks". BetterBusinessBureau. March 5, 2013.
- Refund Anticipation Loans Come With Risks, Better Business Bureau, 2/26/2013. ' . . The Federal Deposit Insurance Corporation has forced all major national banks to discontinue these types of loans. Be wary of sketchy lenders, both online and off. . '
- Tax refund offers include extra fees, KGET [California], Feb. 7, 2013. ' . . "They have to disclose all the fees so make sure you carefully read any papers that you sign, giving them rights to your refund, because that's exactly what you're doing," said Hudson [Katy Hudson, Consumer Credit Counseling Services President]. . '
- New tax refund loans carry sky-high fees and rates, CNNMoney, Blake Ellis, March 6, 2013.
- "U.S. Dept of the Treasury Circular 230". U.S. Dept of the Treasury.
- "Building a Better Refund Anticipation Check". Consumer Law. Retrieved 2008-10-16.
- "E-filing can make high-fee loans unnecessary - Tax Tactics". MSNBC.com.
- "Cheaper and still fast alternatives to refund anticipation loans".
- "COMPANY NEWS; Bank Challenges I.R.S. on Refunds for Borrowers". New York Times. 1995-02-22.
- Chi Chi Wu, Jean Ann Fox & Patrick Woodall (2006). "The NCLC/CFA 2006 Refund Anticipation Loan Report". Consumer Federation of America & National Consumer Law Center. p. 7. Retrieved 2014-12-10.
- "IRS Withholding Calculator".
- "The high price of refund anticipation loans".
- "The high price of refund anticipation loans".
- "California sues H&R Block over tax refund loans". MSNBC. 2006-02-15.
- National Taxpayer Advocate’s 2007 Objectives Report to Congress, Volume II, The Role Of The IRS In The Refund Anticipation Loan Industry, IRS, page 10, June 30, 2006.
- Attorney General Lockyer Files Lawsuit Against H&R Block for Illegally Marketing and Selling High-Cost Loans as ‘Instant' Tax Refunds, News Release, Office of the Attorney General, State of California, Bill Lockyer, (former) Attorney General, Edmund G. Brown Jr., (current) Attorney General, Feb. 15, 2006.
- IRS to end release of taxpayer debt information, EILEEN AJ CONNELLY (Associated Press), Friday, August 6, 2010.
- IRS Removes Debt Indicator for 2011 Tax Filing Season, (IRS news release), IR-2010-89, Aug. 5, 2010.
- "Republic Bank's refund loans challenged". Louisville Courier-Journal. December 16, 2008
- "The threat to a lender of last resort". SmartMoney. November 13, 2008.
- "Instant refunds no bargain", Chicago Tribune, March 16, 2008
- "E-filing can make high-fee loans unnecessary", MSNBC, 2006-02-15
- Consumer Use of Tax Refund Anticipation Loans, Gregory Elliehausen, McDonough School of Business, Georgetown University, April 2005.
- National Consumer Law Center: Refund Anticipation Loans
- Consumer Complaints About H&R Block Refund Anticipation Loans
- "Refund Anticipation Loans". Center for Responsible Lending. Archived from the original on 2008-04-29. Retrieved 2008-08-03.