Starting next tax season, the Internal Revenue Service will no longer provide tax preparers and financial institutions with a so-called debt indicator that is often used to facilitate refund anticipation loans.
The IRS has been reviewing refund settlement products, such as RALs and refund anticipation checks, as part of its return preparer review, in which the IRS announced that it would study refund settlement products.
RALs are loans secured by a taxpayers anticipated tax refund. Currently, tax preparers who electronically submit a clients tax return receive in the acknowledgment file an indication of whether an individual taxpayer will have any portion of the refund offset for delinquent tax or other debts, such as unpaid child support or delinquent federally funded student loans. This acknowledgment is known as the debt indicator, and is used as an underwriting tool for RALs.
RACs are temporary bank accounts established on behalf of a taxpayer into which a direct deposit refund can be received and out of which a bank typically issues a payment to the taxpayer.
With both RALs and RACs, tax preparation and product fees are subtracted directly from the refund, and the taxpayer does not make any out-of-pocket payments. They are frequently marketed to taxpayers who do not have cash to pay for professional tax preparation services.
As we prepare for tax season every year, we look at past practices and consider whether they still make sense, IRS Commissioner Doug Shulman said in a statement. 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.
So far this year, more than 95 million tax returns have been e-filed, representing more than 70 percent of tax returns.
Refund anticipation loans are often targeted at lower-income taxpayers, Shulman added. With e-file and direct deposit, these taxpayers now have other ways to quickly access their cash.
The IRS plans to remove the debt indicator starting with the upcoming 2011 tax filing season. Taxpayers will continue to have access to information about their tax refunds and any offsets through the Wheres My Refund? service on IRS.gov.
In a related effort, the IRS plans to explore the possibility of providing a new tool for the 2012 tax filing season to give taxpayers a mechanism to use an appropriate portion of their tax refund to pay for the services of a professional tax return preparer. The IRS intends to consult with taxpayers, consumer advocates and the tax return preparer community to consider whether providing this option would be a cost-effective way for consumers to pay for tax return preparation services.
House Ways and Means Oversight Subcommittee chairman John Lewis, D-Ga., praised the decision to no longer provide the debt indicator.
"I am pleased that the IRS has ended the debt indicator program for lenders and preparers, Lewis said in a statement. I have been concerned for years that the debt indicator facilitates the availability of refund anticipation loans by limiting the risk to lenders. These high-cost loans target low-income families and those eligible for the earned income tax credit who need money quickly.Given the speed at which federal tax refunds are now delivered, this decision is a win for taxpayers who will no longer spend millions of dollars for a 10-day loan."
Senate Finance Committee chairman Max Baucus, D-Mont., also hailed the elimination of the debt indicator. Refund anticipation loans charge taxpayers sky-high interest rates 36 percent or more for access to their own money," he said. "It is reprehensible that banks would use our tax system as a profit center to exploit taxpayers and todays announcement takes that problem head on. The IRS announcement today means taxpayers privacy will be better protected and more taxpayers will keep their tax refunds where they belong in their own pockets.
However, the head of the third-largest tax prep chain in the country, Liberty Tax Service, criticized the move.
Liberty Tax Service CEO John Hewitt noted that without the debt indicator, banks that provide refund loans would need to use other methods to financially screen clients. As a result, many people who would otherwise receive the loan would be denied, and the fees charged to customers who do receive the loan would be considerably higher because of the additional underwriting risks.
Its a disappointing decision for consumers," Hewitt said. "The demand for refund anticipation loans is customer-driven. We are emerging from the greatest financial downturn since the Great Depression. This really isnt the time to take financial options away from those who choose them, and more importantly need them.
H&R Block also panned the IRS for removing the debt indicator. "Today, the IRS took action that will likely increase the cost of refund anticipation loans for millions of low- to moderate-income taxpayers," said H&R Block president and CEO Alan Bennett in a statement. "We were disappointed by its decision to eliminate the debt indicator - an essential underwriting tool banks use when considering whether to loan money to clients."
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