Low-Income Filers Waiting Longer for Refunds
Linda Chambers doesn’t want to know about the Internal Revenue Service’s beefed-up campaign against fraud. She doesn’t care about the computer programming woes, nor is she interested in statistics on the volume of tax returns sent in at this time of year. She has just one question, and she wants a straight answer.
“Where is my money?” wails the Baltimore mother of two.
Chambers, who works in a high school cafeteria, is among an estimated 7 million to 10 million taxpayers having to wait an unusually long time for their refunds this year. Chambers filed her return electronically in the second week of January and was assured she’d have her refund in three weeks. Two months later, her check is nowhere in sight.
People like Chambers appear to be the casualties in the latest IRS war on tax fraud. This year, the IRS is delaying up to half the refunds shown on returns claiming the earned income credit--a generous tax break for the working poor--while tax officials scan the returns for signs of cheating.
This and other anti-fraud programs this year have made quick loans secured by expected tax refunds virtually impossible for low-income taxpayers to get. And the few refund-secured loans that are being made are costing twice or three times what they did a year ago, tax officials say.
For many low-income filers, who often rely on tax refunds to catch up on overdue bills, make rent deposits or buy big-ticket items, there is no choice but to wait.
“We had to make do without a stove for a while,” said Derrick Miller, a telephone representative whose refund came five weeks late. “We talk about the refund like it was a regular (pay)check. It’s not, but because I was told to expect it in three weeks, I did.”
Tax preparers and refund lending companies are so steamed about the delays that they’ve launched aggressive public relations campaigns maligning the IRS. One company, Beneficial National Bank of Wilmington, Del., filed a lawsuit.
The IRS counters the criticism with statistics: Roughly 20% to 25% of all claims for the earned income credit are overstated or bogus. The agency’s “pay now, audit later” method, in effect until this year, was costing American taxpayers between $1 billion and $5 billion annually. Aggressive steps were warranted and necessary--even if innocent taxpayers were harmed, tax authorities say.
To understand why this anti-fraud program is causing such a furor, a little history lesson is necessary.
The IRS and dozens of tax preparation companies have worked hand-in-hand since the late 1980s to promote electronic filing. The taxpayer has the preparer fill out the return forms in a computer and send the data directly to the IRS via modem.
Preparers advertised the service, and the IRS promised taxpayers they would get their refunds within three weeks if they used it.
The IRS gained because returns were filed earlier, errors were less likely and the agency didn’t need to hire typists to feed taxpayer information into the massive IRS computer system.
For preparers, the new system encouraged some 9.5 million individuals to come into tax offices between January and April. They paid upward of $60 each to have their returns prepared and transmitted to the IRS. Then, a stunning 70% of electronic filers would pay for “refund anticipation loans,” which allowed them to get cash for their tax refunds within 24 hours of filing.
The refund loans generally cost $44 to $64, depending on the preparer and the bank making the loan. Better yet, the loans were short-term--of two to four weeks in duration--and virtually risk-free. The annualized interest rates on some refund loans were as high as 75%.
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How did the banks know the loans would be short-term and risk-free? Because the IRS told them so.
When the filing service transmitted the taxpayer’s return to the IRS, the IRS would search government computer records for indications of any other debt to the government, such as a delinquent student loan or a federal tax bill. Within 24 hours--and before the taxpayer got the check for the refund-anticipation loan--the IRS would signal the result of the search.
If the IRS did not plan to seize the refund to pay another federal debt, the preparer would get a green light--the so-called “direct deposit indicator”--meaning the refund check would be deposited directly to the lender bank within three weeks.
In the main, this cozy arrangement worked nicely. Tax preparation firms made a tidy sum, and the IRS was able to boost the number of returns filed electronically to 13.5 million in 1994 from 25,000 in 1986. Preparers say the refund loans were the engine driving the growth in electronic filing, a position that may be borne out by statistics. The IRS says electronic filing has fallen by 15% to 20% this year.
What happened? Late last year, the IRS dropped the direct deposit indicator, saying it allowed some people to get fraudulent refunds and flee before the authorities could carefully review their returns.
Refunds were sent out, for example, before the IRS had a chance to determine if the taxpayer’s earnings statement was valid. Students and transients apparently had made up W-2 forms, then put in for refunds from the phantom withholding.
Losing the direct deposit indicator suddenly made the refund loan business more risky. Banks had to evaluate the credit history of the borrower instead of relying on a government promise. That immediately caused two of the biggest players--Mellon Bank and Greenwood Trust--to drop out. The remaining refund loan companies--Beneficial National Bank, Chemical Bank and BancOne of Cleveland--scrambled to add consumer credit data to their computer systems.
The cost of refund loans soared. Then the IRS announced it would not send a refund until it had checked the Social Security number of every dependent named on the return--a departure from past practice that immediately slowed the issuance of refund checks. Finally, in February, the agency began a program called “EITC stripping.” For refund loan companies, it was the last straw.
EITC stripping involves breaking tax refunds in two. Taxpayers who claim the earned income tax credit get a portion of their refunds deposited directly into their bank accounts--as requested by the taxpayer. The other portion, which is usually the far larger amount that results from claiming the earned income credit, is sent to the taxpayer by check, often weeks or months later.
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For the banks, it created a new collection problem. In the past, the IRS sent the entire refund directly to the bank. The bank would use the money to pay off the loan and remit any balance to the taxpayer. That’s one of the reasons default rates on these loans were remarkably low--less than 1%.
The moment EITC stripping became the norm, the banks stopped making loans on the earned income credit portion of refunds. Taxpayers who expect refunds simply because of excess withholding from their paychecks can qualify for refund anticipation loans, but low-income families that claim the earned income tax credit can’t.
Linda Chambers has to wait.
