When you file your tax return and you have a refund coming, it is only natural to be in a rush to get that money.
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Tax preparers big and small are happy to help. They promise to speed up the refund process and have cash in your hands in just a couple of days. To do this, you take out what is called a refund anticipation loan.
Using the most recent IRS data, the Consumer Federation of America and the National Consumer Law Center estimate that approximately 9 million taxpayers – that’s about 1 in 14 - used a RAL during the 2006 tax filing season. The nationwide cost for these quickie loans was nearly a billion dollars, according to estimates.
With the sluggish economy, consumer advocates fear more people will be tempted to use a RAL this year. “Just say no,” urges Jean Ann Fox, director of financial services at the Consumer Federation of America, “because they are extremely expensive.”
Some of the big players in the market, such as H&R Block and JPMorgan Chase, have significantly reduced the cost of their RALs, which is helping drive down the price industry-wide. Even so, that short-term loan still has a staggering interest rate.
The Consumer Federation of America says the effective annual percentage rate for most RALs ranges from 50 percent to nearly 500 percent. Include the application fees in that calculation – anywhere from $60 to about $135 – and those APRs are from 80 percent to nearly 1,200 percent!
“We’d be outraged if our credit cards cost more than 18 percent interest,” Fox says. “So why would you pay over 80 percent to borrow money for less than two weeks?”
A refund anticipation loan is a real loan. It is not a faster refund from the IRS. You are borrowing money from a bank until your refund arrives to repay that loan – and that involves some risk.
If some of your deductions are disallowed, or the IRS does not approve some of the tax credits you were expecting, your refund won’t be big enough to repay the loan. If you can’t come up with the extra money, that interest clock will continue ticking.
Most of the big tax preparation services make it clear that a RAL is a loan. But Chi Chi Wu, staff attorney with the National Consumer Law Center, says some independent preparers don’t do that. They call it a “fast refund” or a “speedy refund” which, she says, “can be misleading.”
This victim learned her lesson
For years, Chicago resident Rhonda Jones used refund anticipation loans to get her refund and earned income-tax credit. When you are working three jobs to make ends meet, you want to get that money as quickly as possible.
“It was the biggest rip-off in the world,” Jones says. “They’re taking advantage of low-income folks, because they need the refunds the most.” Jones hasn’t used a RAL since 2003 and is proud of that. “I’m not paying anyone for my money,” she tells me.
Now she’s helping others do the same. Jones volunteers with the Center for Economic Progress, a non-profit group in Chicago that offers free tax preparation for low-income families and individuals.
A few words from H&R Block
I asked H&R Block, the nation’s best-known tax preparer, to talk to me about RALs.
In a written statement the company said, “We believe the best option for our clients is to file electronically with the IRS and to receive an IRS direct deposit rather than taking out a RAL.”
But the company said many of its customers can’t do that because they don’t have bank accounts. Without a RAL, the company says, they would have to wait a month to get their IRS refund check in the mail.
“We aren’t callous to the fact that tens of millions of familiesconsider their tax refund to be an important financial asset that sometimes involves immediate needs.”
Should the IRS restrict RALS?
In order to get a RAL, the tax preparer must share the client’s tax return with the bank providing the loan. This cannot be done without the taxpayer’s written consent. But that permission is usually buried in a stack of documents customers are told to sign when they pick up the return.
“Are you going to be paying attention to the privacy form or are you just going to sign?” asks NCLC’s Wu. “And that’s what we’re really concerned about; sharing information with boilerplate consent.”
Last month, the IRS announced it was considering whether to write rules that would restrict the sharing of tax return information to market RALs. Consumer groups support the ban.
“We don’t think your tax return should be used for any purpose other than filing your income taxes,” says CFA’s Fox.
She also worries that RALs have a negative impact on the filing process and could possibly contribute to tax fraud.
“The fact that they’re going to make more money by selling you a loan may be an incentive to inflate the size of the refund they claim for you, or encourage people to claim factors that would help them qualify for certain tax credits,” Fox says.
The IRS is taking comments on the issue until April. In a news release, the IRS noted that it is “concerned” RALs and similar products may provide preparers “with a financial incentive to take improper tax return positions in order to inflate refund claims inappropriately.”
(You can comment on IRS Reg. 136596-07 at this Web site.)
My two cents
Clearly, it’s best to avoid RALs, but if you need to use one to get your refund in a hurry, at least shop around. Prices vary greatly from company to company. Compare the fees. Compare the APR. That is the only way to know which loan is the least expensive.
Just remember, when you use a RAL, you are paying money to borrow your own money. You can get every penny of your refund back in eight to 15 days if you file electronically and have the refund direct-deposited into your bank account.
One more thing: If you find yourself paying for a RAL or waiting by the mailbox for your refund check year after year, it would be smart to change the amount of tax withheld from your paycheck. Why let Uncle Sam borrow your money all year long, interest free!
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