Refund Anticipation Loans
GAO-08-800R: Published: Jun 5, 2008. Publicly Released: Jun 5, 2008.
Taxpayers who do not want to wait for their tax refunds from the Internal Revenue Service (IRS) may choose to obtain refund anticipation loans (RAL). RALs are short-term, high-interest bank loans that are advertised and brokered by both national chain and local tax preparation companies. Although the annual percentage rate (APR) on RALs can be over 500 percent, they allow taxpayers to receive cash refunds quickly--sometimes within the same day and even within an hour of filing their tax returns. After filing a taxpayer's return electronically, the tax preparer works in cooperation with a bank to advance the refund as a loan minus tax preparation costs, other fees, and a finance charge. As part of the RAL process, the taxpayer provides authorization to IRS to send the refund directly to the bank to repay the loan. Despite the benefits of receiving cash quickly based on an expected refund, IRS officials and others have raised concerns about whether taxpayers are fully aware of the costs involved and their tax filing alternatives. For example, in a 2007 report to Congress, the IRS National Taxpayer Advocate questioned whether RAL consumers actually understand the nature of the loan product they are receiving. According to the Advocate, while tax preparers offering RALs are required to obtain taxpayers' signatures on written disclosure forms, there are no requirements that such disclosures be made orally. The Advocate wrote that despite the written disclosures provided to them, consumers may not fully understand that the RAL is in fact a loan and not simply a way to receive a faster refund from IRS. Further, without an oral explanation, consumers may lack a general understanding of the nature of the product and its impact on credit reports, as well as other consequences of default. In January 2008, in order to address this issue, IRS and the Department of the Treasury (Treasury) indicated in a Federal Register notice that they were considering rules to prohibit tax preparers from marketing RALs based on information gathered during the tax preparation process. In their notice, IRS and Treasury cite concerns about tax preparers improperly inflating refunds in order to market RALs, particularly when working with customers eligible for the earned income tax credit (EITC). IRS studies have found that this credit is particularly susceptible to fraud, in many cases perpetuated by paid tax preparers. In 1999, an IRS compliance study found $10.4 billion of overclaims on the EITC, of which $7.2 billion (70 percent) was attributed to tax returns completed by paid preparers. Based on continuing concerns over how RALs are marketed to taxpayers, Congress requested that GAO perform a limited investigation to identify examples of where RALs are marketed and the types of information tax preparers disclose to potential RAL applicants.
RALs are marketed by tax preparers that operate in a wide variety of businesses, ranging from major retail stores to automobile dealers and shoe stores. Of the 40 tax preparers we called or visited, 37 offered RALs. 13 tax preparers offered year-round tax preparation in their own stand-alone offices, while 27 were open only during the tax season and operated at tables or desks within existing businesses offering other products and services. Of these 27 preparers, 13 were located in businesses that target low-income customers; however, 14 chose the locations of their businesses because of low overhead costs. One tax preparer we observed minimized overhead costs by operating out of a trailer in the parking lot of a gas station. Tax preparers we visited were generally willing to provide information about RALs, but did not use a consistent method to calculate their advertised APRs. 27 of the tax preparers we called or visited were located in existing businesses in order to market to the businesses' customer base, and 13 of these were located in businesses targeting low-income customers. IRS data show that RALs are disproportionately purchased by low-income taxpayers, and some seasonal tax preparers market to this population by operating within businesses that serve low-income customers, such as check cashers, payday loan vendors, rent-to-own stores, and pawn shops. We found 14 tax preparers that operated within existing businesses in order to take advantage of low overhead costs but did not specifically target low-income customers. These included those in a vending service company, a small business services company, and a van rental store. In general, these businesses did not offer any incentives to attract tax customers to their primary products. Some national tax preparers also market RALs by offering tax preparation in major retail chains. Tax preparation services in these retail stores are seasonal and generally close around April 15. Several of the businesses we observed offered multiple services unrelated to tax preparation. We found that tax preparers were generally willing to provide information about RALs during the tax preparation process. All 5 preparers that completed federal and state tax returns for our fictitious taxpayers gave an estimate of the fees and finance charges associated with a RAL based on our refund amounts. During our visits, we did not experience any pressure to apply for a RAL. Of the 40 tax preparers we called or visited, 6 discouraged us from applying for RALs because of the high interest rates or the short time it actually takes to receive a refund directly from IRS. Tax preparers offering refund anticipation loans must abide by the requirements of the Truth in Lending Act and the IRS Handbook for Authorized IRS e-file Providers of Individual Income Tax Returns. Some of these advertisements gave sufficient information on APRs, finance charges, and other fees to determine how the preparer had arrived at its advertised APR, while others gave only limited information.