Sunday, August 8, 2010

Refund Anticipation Loans - Bye bye?

If you're reading this blog (Thank you!) then you are probably seeing other news items and have read, over the last 3 days, about a change at the IRS and how this will impact the Refund Anticipation Loan (RAL) business and users. I'll offer my thoughts on this too.

For those unaware, this paragraph will have the short details. The IRS receives from other branches of the government information about what taxpayers owe. This could be related to Social Security, back child support, whatever. They do NOT receive information about what the issue is. When a tax return is e-filed the IRS in the acknowledgment indicates if the refund will be processed normally or if there is an "offset" from a prior tax problem or other government agency that will cause the refund to be held. Banks use this flag to help determine whether or not to write a loan to the taxpayer allowing for the early refund. Without this information if the bank chooses to issue the loan it really does not know if the loan will be repaid by the IRS or not.

The expectation is that RALs may die a quick death. Some speculate that if a taxpayer has had a RAL from the same bank for multiple years then maybe the bank will write the loan anyway. Of course the taxpayer does not choose the bank - that is done by the tax professional in their annual contract. Others speculate that RALs will continue but the fees will escalate significantly to pay for the additional risk that the bank must take.

Many advocates are very please with this happening. Why? The majority of these loans take money out of the pockets of those who need the money the most. One report indicates that in 2008 over $700 million was skimmed away from the low-income portion of our population. One tax preparation chain indicated that their average interest rate on these loans (assuming it expedites the refund by 1 week) was over 80%. I personally have seen these loans at around 180% annual interest rate. The NY state banking department reported loan interest rates approaching 700% in some extreme cases. (Can you spell usury?) One chain even reported in its financial statements that it lost money on tax return preparation but made a profit due to the RAL business. Tax return preparation is just a loss-leader for them.

Others argue that people need these loans. Really? They argue that people are in dire straights - behind on their rent, or with a car in the shop - and these loans are the only way to meet payment commitments. Hmm. For the last 12 months there was no loan coming in. How was the rent paid then? Do these people voluntarily put themselves in this predicament simply because they know they can get that loan money next week? Might they behave differently if it could take one additional week?

Currently almost all refunds are paid within 10 days. A RAL will shorten that to 1-3 days. The IRS has piloted a new e-file system that will provide refunds in 3 days. That's not yet available to everyone, but it was used this past year on many of the simpler returns. Those are the same returns that generally end up with a RAL. Granted this 3-day refund from the IRS is only available to those who choose direct deposit.

Next proponents of RALs point out that many taxpayers do not have bank accounts and there fore are unable to use direct deposit. Isn't a Social Security number and photo ID all that is required to open a bank account? Maybe the slice of our population that will be disadvantages is more narrow that previously acknowledged. Who is unable to have a Social Security number and photo ID???

Interesting that this target slice of our neighbors that get the RAL check, after paying hundreds of dollars to save a few days, must then go to a check cashing business and pay fees again, since they do not have a bank account to deposit the check. No wonder opponents point out that significant money is being siphoned away from the poor and channeled to the rich. This whole process smells of this.

People survived for decades without quick access to their refunds. Proper tax planning will reduce those refunds to a rather minimal amount anyway. People will adjust to the extra delay - where it will really exist. The bottom line will leave a lot more money in the pockets of the lower-income portion of our population. That seems like a good thing.

Oh, the other issue is that some people use this method to pay the tax preparer. That appears to also be in danger. The IRS did state that there is a proposal in process to offer a new capability for that in the 2012 filing season (tax year 2011). So maybe the burden of having to directly pay for services received will only last one year. That too we can survive. To genuinely help our poor, it seems worth it.

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