North Carolina Consumers Council

This article appeared in the NCCC newsletter, dated February 2008.

With the opening of another tax season, the National Consumer Law Center (NCLC) and Consumer Federation of America (CFA) are warning taxpayers to steer clear of refund anticipation loans (RALs), one of the most avoidable tax-time expenses.

New figures reveal that RALs drained the refunds of nearly 9 million American taxpayers in 2006. This figure has declined from a high of 12.4 million in 2004, but still represents $900 million in loan fees, plus over $90 million in other fees. In addition, another 10.8 million taxpayers spent $324 million on other types of financial products to receive their refunds.

The price of RALs has declined significantly for some of the biggest players in the industry, introducing new price competition. Even with lower prices, however, consumer advocates urged taxpayers to avoid RALs.

“Taxpayers can save themselves loan fees altogether by just saying ‘no’ to quick refund loans,” advised NCLC Staff Attorney Chi Chi Wu. “Taxpayers shouldn’t forget that these are loans, and they carry the risk of loans, including unmanageable debt if your refund doesn’t arrive as expected.”

RALs are bank loans secured by the taxpayer’s expected refund -- loans that last about 7-14 days until the actual IRS refund repays the loan. That’s the first indicator of just how unnecessary most RALs are: Most taxpayers could have their refund in two weeks or less even without the costly loan.

“For a free quick refund, file electronically and have your refund direct deposited to your own bank account,” says Jean Ann Fox, Director of Financial Services for CFA, “You’ll generally receive an e-filed, direct deposit refund within 8 to 15 days.”

Using the most recent data available from the IRS, NCLC and CFA calculate that approximately 9 million taxpayers received RALs in the 2006 tax-filing season (for tax year 2005). For that year alone, about 1 in 14 ­­ tax returns involved a RAL.

Although high, that 9 million figure is much lower than the high of 12.4 million RALs reported for 2004. Part of the 2006 decline, however, is probably due to better reporting.

In 2006, the IRS required tax preparers for the first time to separately report RALs versus non-loan refund anticipation check (RACs) products. Thus, prior data may have included RACs that were erroneously reported by tax preparers as RALs.

The IRS data for the first time help determine the amount taxpayers paid for RACs. In 2006, nearly 10.8 million taxpayers received a RAC, at a cost of about $324 million. Taxpayers who have a bank account can avoid the expense of a RAC (generally about $30) by having their refunds direct deposited into their account, which is just as fast. In addition, Block customers who received the Emerald Card last year can have their refunds direct deposited onto those cards, and avoid a RAL or RAC.

The price of a RAL includes several components –

• A loan fee ranging from $32 to $130, which is usually broken down into a “Refund Account” fee and a “Bank Fee.”

• A separate fee charged by the tax preparer, often called an “application” or “processing” fee, of about $40. H&R Block does not charge this fee. Jackson Hewitt does not charge the fee in its company-owned stores, but some franchisees might charge a fee.

In general, the effective annual interest rate (APR) for a RAL can range from about ­50% to nearly 500%. If application fees are charged and included in the calculation, the effective APRs range from about 80% to nearly 1,200%.

Block and JPMorgan Chase have lowered their RAL fees, claiming that these loans bear an effective APR of 36%, which is the traditional small loan rate cap in many states.

However, these figures do not include the “Refund Account” fee, which they claim is for the temporary account into which the taxpayer’s refund is later deposited to repay the RAL. If the Refund Account Fee is included, it more than doubles the APR.

Nonetheless, Block and JPMorgan’s price reductions do represent a real and significant reduction in cost to consumers. For example, a RAL in the amount of $2,600, which is the average refund, costs from $57.85 to $110. Taxpayers should avoid RALs in the first place; but if they insist on getting one, they should shop around.

Tax preparers and their bank partners also offer an “instant” same day RAL for an additional fee, from $25 to $85. Some of the APRs for an instant RAL of about $1,500 are 168% (Block) and 192% (Chase). Santa Barbara Bank & Trust offers an instant RAL of $1,000, which if the taxpayer applies for a “traditional” RAL, may be repaid from the proceeds of the second loan. In that case, the instant RAL could be a 1-day loan that carries an APR of over 1400%.

On January 3, 2008, the IRS issued a request for comments regarding whether it should develop rules restricting the sharing of tax return information to market RALs, RACs, audit insurance and other financial products typically sold to low-income taxpayers.

It appears that the IRS has taken a modest, but positive step, toward RAL reform. However, the critical question is whether the IRS will actually take action after receiving comments, and write tough rules governing RALs.

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