Bankruptcy

IRS Should Have Gone for a Baker's Dozen with RAL

By Katie Porter

Each year the IRS releases a Dirty Dozen of tax scams. I wish the 2008 list had labeled another practice a scam--refund anticipation loans or RALs. A RAL is a short-term cash advance against an anticipated tax return. Essentially, the taxpayer is paying to access their own money immediately rather than waiting for the IRS to process their refund. There are about 9 million RALs made each year, with APRs ranging from 50% to 500%. Perhaps their high fees are justified by the fact that they are short-term loans. On the other hand, the tax preparers have a lock on this market, which could reduce competition. It seems hard to believe that the risks of nonpayment are very significant when the amount of the refund is being determined during the tax preparation process and the preparer captures the refund directly, rather than relying on voluntary remittance from the debtor.

The IRS does warn against "dishonest" tax return preparers who "make their money by skimming a portion of their clients? refunds." Although most leading preparers offer RALs, I think RALs are "making money by skimming clients' refunds."

If a taxpayer electronically files and has their refund direct-deposited, they could get their refund in just 8-14 days. An RAL borrower pays a hefty fee for such a short-term loan. From a policy standpoint, the more disturbing aspect of RALs is that about 60% of borrowers are recipients of the Earned Income Tax Credit. For an EITC taxpayer, an RAL is essentially a shift of the government dollars that are designed to help them improve their financial prospects to the profits of a private tax preparation preparer.

The IRS is considering regulations that would limit the use of tax return information to market RALs. Comments may be made online until April 7th.

Full post as published by Credit Slips on April 02, 2008 (boomark / email).