Experts: Beware of Tax Refund Anticipation Loans

Elizabeth Robinson of Newport, Tenn., a 40-year-old single mother with one grown daughter and two at home, worked as a housekeeper last year. When she filed her taxes last month, she used a nationally known commercial tax preparer and qualified for the Earned Income Tax Credit available to families with incomes under about $35,000.

Faced with an unusually high electric bill of more than $80, Robinson opted for a refund anticipation loan, or RAL, which offers a tax refund within a few days and is secured based on a taxpayer's expected refund, including the EITC, which reduces the amount of tax a filer owes and may be returned with the refund. And that, she said, turned out to be a mistake.

At first, she was told it would cost $172 up front to have her taxes filed and mailed in with the RAL, but after she threatened to leave, the company knocked it down to $144 plus a preparer's fee and bank fee, she said. Her refund, which would have been $794, ended up being $609.

"I was vulnerable, and I was at their mercy," Robinson said, adding that she had used RALs in the past but never paid that much. "I wouldn't have done that if I didn't have to get my electric bill paid … but the jacking up of the fees, they're taking advantage and it's not right."

Robinson is not alone. Experts say those most likely to use RALs are those who can least afford them, and they either do not know about free tax-assistance programs or don't have bank accounts that would allow a quick direct-deposited refund from e-filing with the Internal Revenue Service.

Many Pay Unnecessary Fees

According to a new report by the Children's Defense Fund, two out of three people qualifying for the EITC use commercial tax preparers for their returns. It also found they paid $690 million in loan charges in 2003, which rises to $2.3 billion if the cost of commercial tax preparation is included. IRS figures show that 79 percent of RAL recipients in 2003 had adjusted gross incomes of $35,000 or less, according to the CDF report.

"It's a multimillion-dollar industry, and they target low-income filers because those are the people who live paycheck to paycheck," said Rachel Cooper, research coordinator for the Children's Defense Fund-New York.

"So they obviously know they're the ones most vulnerable for taking these. Middle-income families don't really need a RAL because they can wait [for a refund]," Cooper said. "For low-income families, they think, 'Oh, I can get my money immediately.' A lot of people don't really realize what they're getting, or more so that they could get their money from the IRS now just by e-filing."

Cooper said it can be hard to get the full picture about RALs by looking at commercial tax preparers' literature. "A large percentage of people don't realize that they're taking a loan, and with that they don't realize the consequences of taking a loan," she said.

Alan Berube, a fellow in urban policy at the Brookings Institution who has studied RALs, said data from 2003 shows that between 35 percent and 40 percent of filers who qualified for the EITC used the high-priced loans. "The use of refund anticipation loans is mainly among low-income filers," he said. "High-income filers don't use this product at all, really."

Protecting Taxpayers

It troubles Berube that those who opt for RALs seldom can really afford them. "What enables them to purchase the product is the fact that the Earned Income Tax Credit, for a lot of families, is a significant source of income," he said, adding, "They're still not making much at the end of the day, so spending $100, $150 on any financial products … I think that's a situation we all need to be concerned about."

Sen. Daniel K. Akaka, D-Hawaii, agrees. Last month, he introduced the Taxpayer Abuse Prevention Act, which, among other provisions, would prohibit RALs that use EITC benefits.

"Too many working families are susceptible to predatory lending because they are left out of the financial mainstream," Akaka said in a statement. "Many of the unbanked are low- and moderate-income families that can ill afford to have their earnings unnecessarily diminished by a reliance on high-cost and often predatory financial services."

In addition, his bill would end the Debt Indicator program, which shares extensive personal information of taxpayers with tax preparers, and it would prohibit mandatory arbitration clauses for solving problems with RALs. It also would require the Treasury Department to help low- and moderate-income taxpayers to open a low-cost direct deposit account that can be used for refunds from electronic filing.

Berube said an aspect of the legislation that deserves further consideration is the IRS' role in facilitating these loans. Preparers contact the agency before they make a loan to see if the borrower has any outstanding debt that could cause a refund to be offset, such as back taxes or student loans that are owed to the federal government. "So in effect, the IRS is giving tax preparers this product that enables them to make these loans with really no associated risk," he said.

CDF supports Akaka's bill, and it also is working within low-income communities to steer taxpayers to free tax assistance through Volunteer Income Tax Assistance sites, which offer IRS-trained preparers who work with those qualifying for the EITC.

"Taxes are threatening to people," Cooper said. "They're confusing to people. They just do what they're told. They don't really realize they should have the same kind of attitude as if they're going into a used car dealership … they get as much money out of you as they can."