Refund Loans Cost Taxpayers and Treasury

At a time when most consumers are scrambling to find extra cash each month, many of them also are expecting sizable tax refunds. Syndicated financial columnist Humberto Cruz points out that the average 2008 refund topped $2,400--the equivalent of $200 a month (Tribune Media Services March 8).

A National Consumer Law Center (NCLC) and Consumer Federation of America (CFA) study indicates that many taxpayers in need of fast refunds apply for refund anticipation loans (RALs), at a high cost to themselves and, surprisingly, even to the U.S. Treasury.

CFA reports that the effective interest rate for an RAL can range from about 50% annual percentage rate (APR) to nearly 500% APR. Most taxpayers could have a refund in less than 14 days - without the pricey loan.

For 2007 tax filings (for tax year 2006), one of 15 tax returns involved an RAL, according to Internal Revenue Service (IRS) data for the latest year available and analyzed by NCLC and CFA. Nearly two-thirds of RAL recipients are earned income tax credit (EITC) recipients, although they make up only 17% of taxpayers.

The loan fees, combined with the influx of spendable money coming to recipients, motivate "fringe tax preparers" as diverse as payday lenders, beauty salons, and liquor stores. As one consequence, a 2008 IRS study revealed that RAL returns are 27% to 36% more noncompliant than returns without a loan product, compromising the integrity of tax administration.

Taxpayers have several better options:

• Claim your tax refund in each paycheck; file an amended W-4 with your employer to have less money withheld each payday.
• Divert that extra cash to automated bill payments to pay down debt and/or to your savings account to build your emergency fund.
• Pass on the unnecessary refund loan. Instead, e-file and you'll have your refund in just a few days.
• If you must have refund money for an urgent need, talk to a credit union loan officer about a fairly priced short-term loan.