Tax season is upon us and millions of Americans are anxious to obtain their oh-so-important refunds. If you fall into this group, try not to let impatience push you into opting for a refund anticipation loan without first carefully analyzing the costs.
RALs are loans made by banks, in cooperation with tax preparers, to be repaid when the tax refund arrives. Though these loans are sometimes necessary, they can be a high-cost convenience that most are better off without.
How do Refund Anticipation Loans Work?
A preparer who offers RALs will ask if you are interested in obtaining your refund almost immediately. As part of the tax preparation process, you will complete an application for a RAL and be charged both a RAL fee and a refund account fee for setting up a dummy bank account to receive your refund from the IRS. When the IRS pays the refund, the lender takes the money from this account to repay the loan. These fees vary between preparers, but as an example, in 2008 H&R Block charged 1.07 percent of the loan amount plus a $29.95 refund account fee. The fees charged by other preparers can be much higher.
On an average refund of about $3,000, expect to pay anywhere from $62 to $110 to the major players in the RAL market. For independent preparers, the fees can be higher. While this doesn't sound like much for a quick turnaround of a tax refund, your annual percentage rate for the loan equates to anywhere from 77 percent to 140 percent. Some preparers charge other fees that make the rates even higher. On smaller loans, the annual percentage rate can approach 500 percent.
What is Wrong With a RAL?
First, it is important to note that preparers who follow the rules are not doing anything illegal. They are simply providing a service - though somewhat expensive - to their customers.
A key point to remember is that RALs are loans and must be repaid. If the IRS denies your refund, you are on the hook to repay the loan from other funds. This point is lost on some taxpayers.
Since many individuals receiving RALs are lower income taxpayers who claim the Earned Income Tax Credit, the fees charged by preparers and banks reduce the value of that credit. Additionally, the availability of such loans can be a powerful incentive for unscrupulous preparers to falsify income tax returns. By the time the tax fraud is discovered, the preparer is long gone. The result is a consumer with a tax liability, penalties and interest - who actually paid to be put in that position.
Some tax preparers use RALs to hide the true cost of their services. It is not unusual for a preparer to advertise extremely low fees for tax preparation only to tack on other fees. For example, one Baltimore preparer advertised a $36 tax preparation fee, and then added on a $185 electronic filing fee and a $10 transmission/software fee for a total of $195 in added fees. Because these fees are sometimes withheld from the RAL, the true cost of services is hidden from the customer.
Many taxpayers can avoid the high fees by waiting the two weeks it typically takes the IRS to deposit a refund in their bank account.
Is there Anything Good About a RAL?
In some instances, a RAL can be a lifesaver. There are times when you need funds fast to avoid a catastrophe, like the power company cutting off your electricity. In these situations, the RAL can be an effective lifeline.
If you are impatient and simply want your refund immediately, the RAL is a viable alternative, as long as you understand the true cost and risks of it. Just be sure to take time to shop around for the preparer offering the lowest overall cost for this service.
Protect Yourself
Often, taxpayers fail to review their returns after a paid professional has completed it. Such blind trust in the preparer is misplaced.
Recent studies by consumer groups and U.S. Government agencies using mystery shoppers produced disturbing results. Many of the preparers were either incompetent or blatantly manufactured deductions to increase refunds. In one study, every preparer calculated a refund when the taxpayer really owed a small amount.
Be certain you are dealing with a reputable preparer. Those at car dealerships or other store fronts might not have the training or expertise to properly prepare your return. Their objective is to maximize your refund so you can purchase what they are selling, and that could mean a higher risk of filing a fraudulent return. Even though you use a paid preparer, you are still responsible for everything included on your return.
Your best protection is to investigate the training and reputation of a preparer. There are no guarantees, but utilizing the services of commercial firms that require employees to attend training reduces your chance of filing a false return. Using professionals like CPAs or attorneys further decreases your chances of submitting a noncompliant return. You still need to review your return and question anything you don't understand. Competent professionals welcome your review and will attempt to fully answer your questions; incompetent preparers will not.
Conclusion
In some situations, refund anticipation loans serve a purpose for the consumer, but often at a high price. If you find that you need a RAL, or if you simply wish to obtain your refund quicker, take the time to investigate the reputation and fees of preparers in your area before purchasing their services. Insist on a full accounting of fees you will be charged. You will likely find it worthwhile to wait a few extra days for your refund. Above all, take the time to review your return before it is filed. We look forward to serving you in 2010 and wish you a happy and prosperous New Year.
