"Quick Tax Refunds" What's Real? What's Really a Loan?

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• Promotion and presentation of quick tax refund loans are often misleading. Most promotions emphasize the speed with which you'll get your money not the fact that what you're getting is a loan. Studies show that many consumers never realize the check or cash they've gotten is a loan not their refund. Even where companies state clearly that their product is a loan, they may not mention that fact until after a consumer has signed the RAL application. In other cases, paperwork may bury the loan information in fine print, or a customer may be given a stack of papers and directed to sign various lines (including the loan agreement) without looking fully at the papers.
• High costs characterize RALs. An exorbitant interest rate is the first high cost. Loan fees that typically range from about $30 to $125 may seem small until you realize that they translate into triple digit APR's for what's typically an 8 or 9 day loan. In addition, many tax preparers or other companies offering RALs charge application fees and fees for “refund accounts” for taxpayers who don't have bank or credit union accounts—these fees can more than double the effective interest rate. Many taxpayers using these fee services would probably qualify for the IRS's free electronic filing program (more about that below). Total cost to 9.6 million RAL borrowers according to CFA/NCLC figures for 2005 (2004 tax year): About $960 million for loan fees and $100 million for other fees. These figures are down from the previous year, but still account for over 1 billion dollars. In addition to loan-related fees, most customers also pay fees for tax preparation service. The average tax preparation fee is about $150; actual fees may be lower or much higher.
• A refund loan doesn't actually save much time. Getting a check in two days seems to be the time frame featured by most companies offering RALs; these companies typically also prepare the tax return and file it electronically. The IRS notes that if the taxpayer files a return electronically and has the refund direct deposited into a bank account that the taxpayer can expect the refund usually within 10 days. Costs that can range into the hundreds of dollars are really steep for what amounts to an eight-day or nine-day loan.
• Taxpayers are still responsible for the full loan even if the IRS disallows part or all of the refund. If for any reason (such as a mistake made by taxpayer or tax preparer, a disallowed deduction or unpaid student loans or child support), the IRS doesn't pay the total refund anticipated or perhaps doesn't pay any refund, the borrower of the RAL is responsible for the whole loan. If you can't pay it back, you can usually expect harassing collection tactics and damaged credit ratings.
• Companies offering RALs typically target low and moderate income taxpayers who are least able to afford the costs. According to the NCLC/CFA 2005 report, over half of customers who got refund loans were recipients of Earned Income Tax Credit (EITC), a government anti-poverty program for low-income families and individuals that's paid out as a tax refund. Because such taxpayers often need help to prepare the complicated application forms for the EITC and may not have upfront the necessary tax preparation fee of $50 and up (sometimes way up), they are easy targets for RALs. Many such consumers also do not have bank accounts which leaves them vulnerable for additional fees to have a “dummy account” set up in their name for direct deposit or fees for a stored value card (a kind of prepaid debit card). An earlier report from the Brookings Institution estimated that $1.75 billion in EITC funds went to pay for “tax preparation, electronic filing and high cost refund loans.” They also found that half the $30 billion of EITC claimed in 1999 was paid out in RALs.
• Some companies use creative ways to jack up fees. In one case reported by CFA and NCLC, in addition to all the fees for preparing and filing the return, the taxpayer received his loan as a debit card—only to find out that he had to pay a fee of $29 every time he used the card to withdraw money. Since he could only withdraw $400 at a time, think how much he paid to access the total amount of his refund loan.

• File your return electronically and have your refund direct deposited to your credit union or bank account. A number of software companies provide software that helps you prepare your federal and state tax returns on your computer and file them electronically over the Internet. If you don't own a computer (or even if you do), they also offer Web-based services where you can open a private file and prepare your tax return from any computer to which you have access. The fee for the software and filing is typically small (some companies include the cost of e-filing in the cost of the software). If you qualify for the IRS Free File program, you need not buy software and can file free on the Internet. Even if you are among the 60% of Americans who feel they need help preparing their returns, try using the IRS Free File program. It is similar to using a commercial tax preparer.
• Use the IRS Free File Program, if you qualify. Starting with tax year 2002, the IRS has partnered with private companies to provide free online filing through the Free File Program. Eligibility requirements vary from company to company, and include income level, age, military status, and state of residence, depending on the company. In 2007 (for 2006 taxes) Adjusted Gross Incomes of under $52,000 will typically qualify for several programs. You can check to see if you qualify by previewing all the participating companies requirements on the IRS website or filling in a Free File Wizard to see which you qualify for. To file your return through the Free File program, you must start on the IRS website. A caution: Consumer groups warn consumers to be aware that since they are dealing with commercial companies that the companies may offer fee-based services that the consumer is under no obligation to take. New rules, however, prevent the companies from advertising RALs.
• Take advantage of free tax preparation help. In communities throughout the country the IRS-sponsored Volunteer Income Tax Assistance Program (VITA) is available to lower and moderate income taxpayers as is the Tax Counseling for the Elderly Program (TCE). Call toll-free 1-800-829-1040 to locate a program near you. The AARP provides AARP Tax-Aide, a free online tax counseling program for the elderly from February 1 to April 15 each year. You can also call your public library which often has information about local tax help preparation. If there is a branch of the IRS in your city, they also provide free help to taxpayers.
• Adjust your withholding—don't use the IRS as a no-interest savings account. If your return comes close to the average of almost $2,000 (or even if it's less), then you can put that money to work for you sooner by adjusting your tax withholding. If you take that money—it would be about $150 a month in our example—and deposit it in your credit union savings account or other savings fund then at the end of the year you would have immediate access to your money and it would have earned some interest. You'd also have access to it anytime during the year you needed it. If you fear you don't have the discipline to voluntarily save that amount out of your paycheck each month, why not see if your employer has plan that allows you to have a certain portion of your check deposited directly to your savings account. Alternatively, if your paycheck is deposited to your DCU credit union checking account you can set up an Automatic Transfer Authorization (ATA) to automatically transfer each month the amount you designate into your savings account.