Tax preparers who arrange refund anticipation loans (RALs)—high-cost loans secured by a taxpayer’s expected income tax refund—have long relied on the IRS to provide information on any outstanding debts, such as back taxes or child support, that will be withheld from the borrower’s tax refund. This information, called the “debt indicator,” allows tax preparers to underwrite RALs and facilitates an industry that strips $114 million from Illinois taxpayers. In a huge victory for consumers, the IRS announced that it would stop providing the debt indicator to tax preparers.
Refund anticipation loans allow taxpayers to receive their expected tax refund in one to three days, compared to the ten days it would take to receive a refund through direct deposit. RALs often come with very high fees and the borrower must repay the full loan amount—with high interest rates—if the refund turns out to be less than expected. Our research has found that, in Illinois, RALs disproportionately strip wealth from tax filers in African-American communities. Almost one in four tax filers in African-American communities use RALs—that means they are 3.5 times more likely to use RALs than tax filers in other communities.
Tax preparers use the debt indicator to estimate the expected refund minus any outstanding tax liens and calculate how much money to lend to the borrower. Without the debt indicator, tax preparers will be unable to accurately estimate what the borrower’s refund will be. It is likely that many tax preparers and the banks that finance RALs will follow J.P. Morgan Chase’s lead and leave the RAL business entirely in the face of this underwriting obstacle.
IRS Commissioner Doug Shulman noted in a press release:
“As we prepare for tax season every year, we look at past practices and consider whether they still make sense. We no longer see a need for the debt indicator in a world where we can process a tax return and deliver a refund in 10 days. We encourage taxpayers to use e-file with direct deposit so they can get their refunds in just a few days.”
Woodstock Institute agrees, and encourages tax filers to e-file in order to get their full refund as quickly as possible. We also welcome the IRS’ intention to study a new tool that would allow tax filers to apportion part of their refund to pay a tax preparer. Low- and moderate-income tax filers often elect to receive their refund with RALs or a refund anticipation check in order to avoid paying tax preparation fees out-of-pocket, and this mechanism would allow them to avoid paying out-of-pocket fees without the additional fees and interest associated with RALs. Low- and moderate-income tax filers may also qualify for free tax preparation services at Volunteer Income Tax Assistance (VITA) sites. To locate the nearest VITA site, call 1-800-906-9887 or visit the IRS website for more information.