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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"
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
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.
Controversy
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".
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.
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 aschild support, student loans, etc.).
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.
This report updates the NCLC/CFA annual reports on the refund anticipation loan (RAL) industry and the drain caused by RALs from EITC benefits. Readers who are interested in background information on the RAL industry and regulation are advised to refer to the first NCLC/CFA RAL Report published in January 2002.2
There has been a bit of progress in the effort to regulate RALs and inform consumers of their true nature and costs. Two states and one city have recently enacted legislation requiring better RAL disclosure. One major tax preparation chain has announced improved written disclosures for RALs. The IRS has required additional disclosures in its Free File program.
However, the effect of even these changes, which are all limited to better written disclosures, remains to be seen. The volume of RALs in 2002, which is the most recent year that IRS has data on, did rise but not dramatically. Data from subsequent years when consumer advocacy focused at a greater level will be more instructive. A limited sampling of RAL consumers from two locales indicates that many consumers remain unaware of the basic fact that RALs are loans. In the meantime, RALs continue to drain over a billion dollars from the pockets of American taxpayers, including EITC recipients.
III. Continued Growth in RAL Volume
The most currently available IRS data indicates a moderate but continued growth in RAL volume. During the 2002 filing season, consumers took out approximately 12.7 million RALs.3 This constituted just under 10% of all individual tax returns filed in the U.S.4
1 National Taxpayer Advocate, FY 2003 Annual Report to Congress, December 31, 2003, at 27 [hereinafter “National Taxpayer Advocate 2003 Report”]. 2 Chi Chi Wu, Jean Ann Fox, and Elizabeth Renuart, “Tax Preparers Peddle High Priced Tax Refund Loans: Millions Skimmed from the Working Poor and the U. S. Treasury,” National Consumer Law Center and Consumer Federation of America, January 31, 2002, [hereinafter “NCLC/CFA 2002 RAL Report”], available at www.consumerlaw.org/initiatives/refund_anticipation 3 The 12.7 million figure was calculated as follows: 1) IRS statistics state that there were 14.1 million tax returns which were associated with a RAL. Data from IRS SPEC, Tax Year 2001 Return Information (Returns Filed in 2002), October 2003; 2) We assume that since IRS would not know whether a RAL was approved or denied, these statistics represent number of RALs applied for. About 90% of RAL applications result in an approved loan. George Guttman, IRS Reinstates Debt Indicator to Increase Electronic Filings, 85 Tax Notes 1125, Nov. 29, 1999. Thus, 90% of 14.1 million is 12.7 million.
In our last RAL report, we estimated based on IRS data that approximately 12.1 million RALs were taken out in 2001, so there was an increase of 5% from 2001 to 2002.5 This compares with an estimate of 10.8 million RALs for 2000, and an increase of 12% from 2000 to 2001.6 In 2002, taxpayers received an average refund of $2,043.7 Based on prices stated by the leading RAL lender, the average taxpayer paid about $90 in RAL fees.8 Thus, taxpayers paid somewhere in the neighborhood of $1.14 billion in RAL fees in 2002. This compares to an estimated $907 million in RAL loan fees in 2001,9 and an estimated $810 million in 2000.10
This $1.14 billion would be even higher if we could include the additional fees paid for an additional loan product called the “Instant Money” (H&R Block) or “Money Now” (Jackson Hewitt) loan. These products are same day loans, by which consumers can receive all or part of their RALs immediately when they file their taxes. Lenders charge an additional $15 to $30 for same-day RALs, a fee which the consumer pays on top of regular RAL fees.11 We do not have data on the number of same-day RALs taken out by consumers.
In addition to the RAL loan fee, major tax preparation firms charge additional fees for RALs, often termed “system administration,” “document preparation” or “electronic filing” fees. The NCLC/CFA 2003 RAL Report included two such fees in the calculation of the total amounts paid for RALs.12 However, we were informed by officials at the largest tax preparation chain, H&R Block, that the company will only charge one such fee. It is not clear if the practices of other major tax preparation firms are similar.13 On the basis of Block’s representations and given that it is the largest chain, we have included only one additional fee this year.
According to Block, its system administration fee ranges from $28 to $59, with an average of $32.14 Using the average figure, these additional fees add about $406 million to the amount paid in RAL fees.
Thus, based upon the prices for RALs in 2004, a consumer might pay the following in order to get a $2,100 RAL from a commercial tax preparation chain this year: 1) a loan fee of $99.95, which includes a $24.95 fee supposedly for the “dummy” bank account used to receive the consumer’s tax refund from IRS to repay the RAL; and 2) a system administration fee that averages $32 per loan. Combine that with tax preparation fees, which average about $120,15 and the total is about $250. The effective APR on this RAL would be 182% (or 245% if the system administration fee is included).
Finally, we note that some tax preparers and RAL lenders have been reporting APRs lower than our estimates.16 Generally what these lenders have done is to "unbundle" or subtract out amounts from the finance charge, and denominate them as something else in order to make the loans look less expensive. In the case of RALs, the lenders subtract out a charge supposedly for the “dummy” bank account, claiming that it is comparable to the charge for a non-loan product, a “refund anticipation check” (RAC).17 However, this unbundling is questionable in that: a) some lenders had not previously separated out an independent fee for the dummy account for RALs;18 2) the fee for the dummy bank account for a RAL versus a RAC serves two different purposes – repayment of a loan versus a disbursement mechanism for cash; and 3) since RALs are a pure cash loan, there is no comparable non-credit purchase transaction to which they can be compared.19
We continue to include the charges for the dummy account fee in our estimates for the APR to present a truer picture of the real “cost of credit” for a RAL. For the 2004 filing season, we estimate that the APRs on RALs range from about 70% (for a loan of $5,000) to over 700% (for a loan of $200).20 We also continue to report APRs that include the system
IV. Impact on EITC
Recently obtained IRS data indicates an astounding impact of RALs on the Earned Income Tax Credit. In the 2002 and 2003 RAL reports, we had assumed based on information provided by IRS that 40% of the RAL customers were recipients of the Earned Income Tax Credit.22 However, more reliable IRS data shows that actually 55% of RAL consumers are EITC recipients, or 7 million families.23 Yet EITC recipients make up only 15 % of individual taxpayers.24 Thus, EITC recipients are vastly over represented among the ranks of RAL consumers.
Furthermore, since there were 19.6 million EITC returns in 2002,25 this means that 36% of EITC recipients took out a RAL.26 We note that paid preparers were responsible for 68% of EITC tax returns in 2002.27 This means that 53% of EITC recipients (over 1 in 2) who went to a paid tax preparer ended up with a RAL.28
Based on these revised estimates, an estimated $525 million was drained out of the EITC program by RAL loan fees.29 Tax preparation fees and “system administration”/electronic filing fees add another $1.06 billion to the drain. Adding check cashing costs, the total drain is $1.75 billion. Each of these fees undermines the effectiveness of the EITC in supporting low-wage workers. These fees transfer billions in wealth, paid out of the U.S. Treasury, from poor families to multi-million dollar corporations.
V. Tax Preparers and RAL Lenders
In 2002, the major players in the RAL industry experienced significant growth. Because 2003 corporate filings are available for some of these companies, this section also includes selected 2003 data.
H&R Block
H&R Block experienced a 14% growth in the number of RALs they processed, from 4.5 million in 2001 to 5.15 million in 2002.32 In 2003, Block began reporting only the number of RALs that were funded after Block processed them.33 Block reported that 4 million of the RALs it processed were funded in 2001, and that 4.67 million were funded in 2002.34
In 2003, the number of RALs processed by Block appeared to have stayed flat. Block reported that it processed 4.65 million RALs that were funded.35 Note that Block actually lost tax preparation customers in 2003, declining from 16.9 million to 16.3 million. In 2002, Block earned over $200 million in fees from RALs.36 This included both a $9 per RAL “license fee” and $160 million in loan fees received by Block Financial Corporation, which had an arrangement to buy a 49.9% interest in RALs arranged by the tax preparation arm. For 2003, Block waived its right to buy this 49.9% interest in RALs, as well as its “license fee” in exchange for a flat fee per RAL.37 In 2003, Block received $133 million in payment for its waivers.38 Block will resume collecting license fees and obtaining its participation interest in RALs until 2006.39 In addition to the participation interest in RALs, Block’s incentives to promote RALs include payments by Household to reimburse Block for the cost of advertising.40
In 2002, Block applied for a charter to become a bank with the Office of Thrift Supervision.41 Consumer groups, including CFA and NCLC advocates, submitted comments raising issues concerning Block’s RAL business, as well as concerns over subprime lending by Block subsidiary Option One and the potential for the Block bank to engage in rent-a-charter payday lending.42 Block withdrew its application in April 10, 2003, but has since re-filed its application in December 2003.43
Finally, H&R Block revealed in December 2003 that it is being investigated by the Securities and Exchange Commission over its disclosures relating to RAL litigation.44
Household Bank/ITLA
In 2002, Household processed 7 million RALs generating nearly $240 million in income.45 This represents a 9% increase in the number of RALs and a 22% increase in RAL income from 2001, in which Household made 6.4 million RALs generating $196.3 million in income.46
As discussed in the NCLC/CFA 2003 RAL Report, Household struck an arrangement in November 2002 with ITLA Capital Corporation for ITLA to originate the RALs, which Household would then buy immediately from ITLA.47 Preliminary data shows that ITLA Corporation earned $14.6 million in income from RALs in 2003.
The following is the Household/ITLA price structure for RALs in 2004, for both H&R Block49 and in general.50 At least for the general rates, there appears to be an increase of about $15 for the loan fee for loans of $2,001 to $5,000.51 Household 2004 RAL Fee Schedule Amount of Loan H&R Block General $200-$500 $29.95 $34.95 $501-1,000 $39.95 $44.95 $1,001-$1,500 $59.95 $64.95 $1,501-$2,000 $69.95 $74.95 $2,001-$5,000 $99.95 $104.95
Jackson Hewitt Jackson Hewitt, the second largest tax preparation chain in the country, prepared 2.5 million returns in 2002.52 Jackson Hewitt generated revenues of $33 million from “various financial products,” which we assume would include RALs and refund anticipation checks (RACs). In 2003, Jackson Hewitt reported that the number of tax returns it processed had increased to 2.8 million.53
Santa Barbara Bank & Trust/Pacific Capital Bancorp Jackson Hewitt’s RAL partner, Santa Barbara Bank & Trust (SBBT), a subsidiary of Pacific Capital Bancorp, earned $29.9 million in fees from RALs in 2002, and $16.6 million in fees from its RAC product, called a “Refund Transfer.”54 SBBT earned $38.2 million in RAL fees in 2003, representing an increase of 28%, and 19.8 million in Refund Transfer fees.55 Thus, SBBT’s RAL business has experienced significant growth in 2003.
Interestingly, SBBT reports that its RAC product constitutes about two thirds of is taxrelated financial products.56 Since SBBT made 3.8 million RALs and RACs in 2002, that means SBBT made about 1.3 million RALs in that year.57 For 2003, SBBT made 4.6 million RALs and RACs, which means SBBT made 1.5 million RALs this past year.58 Note that SBBT also earned $1.6 million in recoveries on bad RAL loans from prior years, presumably through cross-lender debt collection.59 The following is SBBT’s price structure for RALs in 2004.60 Some of these prices appear to be $5 higher than SBBT’s prices in 2003,61 which adds up to $10 given the surcharge for RALs secured by the EITC. SBBT 2004 RAL Fee Schedule Amount of Loan Loan Fee w/o EITC Loan Fee with EITC Up to $500 $29 $34 $501-1,000 $44 $49 $1,001-$1,500 $64 $69 $1,501-$2,000 $79 $84 $2,001-$5,000 $94 $99
Other industry players
In a victory for consumers, Intuit Corporation announced in September 2003 that it would no longer offer RALs through TurboTax, which is the nation’s best-selling do-it-yourself tax software program.62 In addition, RALs would no longer be offered through the Webversion of TurboTax, which was part of the IRS Free File program.63
VI. Partnerships with High Cost Financial Providers
In our prior reports, we have discussed the role played by high cost fringe financial providers in the RAL business, such as the H&R Block partnership with ACE Cash Express.64 We have also reported on car dealers and payday lenders who engage in tax preparation and facilitate RALs.65 These practices appear to be flourishing. ACE Cash Express reports that in 2003, it placed 240 self-serve cash checking machines in H &R Block offices.66 Jackson Hewitt has a similar arrangement with CashWorks to place check cashing machines in Jackson Hewitt
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