As this year’s fling season is winding down, the National Consumer Law Center released a report discussing the filing season issues from the perspective of lower and moderate-income taxpayers. This year’s report discusses some of the main issues in the past filing season, including the Congressionally mandated delay associated with EITC and CTC refunds, the rebirth of a new form of refund anticipation loan, challenges associated with getting a Tax Identification Number, the limited ways in which states regulate commercial tax return preparers, and the onset of private debt collection.
For those of you unfamiliar with the issue, a refund anticipation loan (or RAL) was a loan that banks made and that was secured by and paid with the proceeds of a taxpayer’s refund. In their heyday they were controversial, in part because they were almost always accompanied by high fees and high effective interest rates. In addition there was significant concern that the fees provided the incentive for preparers and banks to encourage improper claims, especially when IRS shared with preparers a debt indicator that let preparers know if the refund were likely to be delayed or intercepted to apply to a past due tax or other offset.
In 2012, RALs in their earlier incarnation dried up after IRS pulled the debt indicator and federal regulators essentially forced banks out of that business. As I discussed earlier this year, many preparers and partner banks brought back the loans this filing season, though with two key differences: the loans 1) had no stated fee and 2) were non-recourse, meaning that if the refund does not materialize due to say a refund freeze or offset the losses were not the responsibility of the individual filer. It appears that for this filing season the RAL is now a loss leader, or a way to bring clients into the door to generate prep fees and perhaps upsell other products that the preparers offer.
Given the statutory mandated delay in EITC and CTC refunds and the mostly no-fee modern RAL, it is not surprising people were attracted to this product. The NCLS report indicates that this year over 1.5 million RALS were issued, up from about 40,000 in 2015.
The report discusses that not all preparers were genuinely offering a no-fee RAL; some had disguised fees and others essentially wrapped in costs with the fee for preparing a return. Prep fees take a big bite out of many lower-income individuals’ refunds; the report discusses the wide range in fees that preparers charge to prepare EITC returns and discusses a survey from the Progressive Policy Institute that indicates EITC recipients can expect to pay between 13 and 22% of their refunds on tax prep fees and related services.
In years past, in addition to the consumer issues, I was interested in the relationship of RALs and noncompliance. I discussed that issue in a 2009 article in Stanford Law & Policy Review called Refund Anticipation Loans and the Tax Gap. Under the old RAL regime, some argued that the combination of high fees, the IRS’s release of the indicator that allowed preparers to know if the claimant’s refund would be offset or likely frozen, and the recourse nature of the loan created a divergence in the preparer’s interest in turning profits and the general interest in submitting claims that relate to eligible claimants. The dynamics have changed considerably. Since I first discussed the issue Congress tightened up due diligence rules; IRS is (albeit sporadically) enforcing those rules among preparers, and now with this new RAL product preparers rather than filers are on the hook for defaults.
From a compliance standpoint it is possible that the current rise in RALs helps ensure that preparers are actually more invested in performing due diligence, or at least more sensitive to the issues (or at least audit risk), as repayment will be based on the consumer actually getting the refund claimed.
As NCLC discusses, however, compliance is not the only issue associated with the product. It comes back to the healthy prep fees that preparers generate. If the individual were already going to use a preparer for the return, then as the report notes the RAL (assuming no hidden fee or truly no passing on of the higher costs) is just a benefit without much additional expense. But there are free options available for many lower or moderate-income individuals, such as the Free File program IRS itself makes available in tandem with the private sector and VITA sites. So to the extent that the product attracts people to high cost preparers, it creates a different dynamic.
In the past it was generally easy to criticize RALs. Now it is not so clear. The costs of RALs this time out are a little less visible though still present for those now using a paid preparer offering a RAL when they otherwise would not. Also, there are now benefits if in fact preparers’ interests are more closely aligned with the government’s in ensuring that eligible claimants apply and receive an EITC-generated refund.