It happens every year: As soon as consumers begin gathering their tax information, tax preparation companies begin trying to talk them into taking out costly loans against any refunds they might have coming. The so-called refund anticipation loans are controversial in the best of times, but critics are turning up the heat on the practice this year, saying that taxpayers' money – courtesy of the $700 billion banking bailout by Congress -- is helping to fund the business.
A consortium of consumer groups recently complained that nearly $200 million in federal bailout money has been given to the bank responsible for most of the tax refund loans marketed by Jackson Hewitt Corp., the nation's second-largest tax preparation company.
"That taxpayer bailout money is being used to fund these high-priced loans is simply outrageous," said Jean Ann Fox, director of consumer protection for the Consumer Federation of America.
Refund anticipation loans, or RALs, are a lucrative business for the tax preparers. In 2006, 9 million consumers obtained such loans, paying $1 billion in fees.
Santa Barbara Bank & Trust is a small bank, but it is a big player in refund loan business. It made nearly 2 million refund loans last year, earning fees of $118 million – nearly half the company's after-tax income, according to the consumer consortium.
Meanwhile, more than one-third of Jackson Hewitt's revenue last year came from arranging the pricey loans, according to a recent article in Barron's.
Jackson Hewitt spokeswoman Sheila Cort confirmed that the Santa Barbara bank is the "majority provider" for its refund loan program, but directed other questions about the program to the bank.
Pacific Capital Bancorp, the holding company for Santa Barbara, said in a statement that it isn't using bailout money to expand its refund loan program.
"The company is utilizing this additional capital to support all of its lending programs, under the spirit of the (bailout). This capital was not intended to nor is it being used to build, to increase, or to fund the company's Refund Anticipation Loan program," it read.
But Fox countered that the bank's refund loan program would not continue if the firm didn't have the money to back such loans – providing the required "capital ratio" needed to continue to pass muster with regulators.
"Money is fungible," she said. "We can't say they are loaning out TARP (bailout) money for refund anticipation loans but (the bailout money) certainly assists the bank in maximizing the number of refund anticipation loans they can make."
How refund anticipation loans work
RALs work like this: When customers of storefront tax preparation companies learn that they have a tax refund coming, they are offered the chance to get the money almost immediately. For a fee, the tax preparer arranges a bank loan for the refund amount. The bank then keeps the refund when it arrives from the government.
IRS rules prevent tax preparation firms from directly granting the loans, so each partners with a third-party bank. H&R Block, the nation's largest tax preparation firm, works with HSBC Bank.
The loan fees are steep when viewed through the lens of a traditional bank loan. Expressed as an annual percentage rate, as required by Truth in Lending requirements, Santa Barbara charges customers an effective annual percentage rate of 113 percent.
Consumers usually are not sensitive to this fee, however, because they don't pay it directly; it is simply deducted from their refund.
Fees vary based on the size of the refund, but a consumer expecting a $2,600 refund could expect to pay about $95 in interest charges plus nearly $40 in processing fees, Fox said. Most must wait a day or two to receive their funds.
Refund anticipation loan consumers may not realize that taxpayers who file electronic returns get their refunds – for free -- in an average of 11 days.
For years, consumer advocates have criticized the loans as unfair and targeted toward the poor. The National Consumer Law Center says that two-thirds of refund loan applicants are recipients of the Earned Income Tax Credit, a special program designed to help poor working families.
"Refund anticipation loans take $600 million out of taxpayer-provided poverty assistance that's supposed to go to working families with children and instead goes to banks," Fox said.
Firms that issue the loans have also attracted the attention of regulators and faced a series of lawsuits. Earlier this month, H&R Block agreed to pay $5 million to settle charges by the California Attorney General's Office that the firm unfairly marketed the loans as early tax refunds. H&R Block admitted to no wrongdoing in agreeing to the settlement. In 2007, Jackson Hewitt paid $5 million to settle charges by the state that it unfairly marketed the loans to low-income consumers. The firm denied any wrongdoing.