Believe it or not, tax season has already begun with a new twist to refund loans.
The tax preparation industry is offering a new breed of high-cost, high-risk loan products targeting the tax refunds of hard working Americans. Called "pay stub RALs" or "holiday RALs," these new loans are a variation on Refund Anticipation Loans, but are made as early as November. Consumer advocates are warning taxpayers to stay away from pay stub and holiday RALs, noting that they drain even more precious dollars from tax refunds and can pose dangerous risks to consumers.
Refund anticipation loans are high cost loans secured by and repaid directly from the proceeds of a consumer's tax refund from the Internal Revenue Service. According to the National Consumer Law Center, Inc. about 12 million taxpayers took out RALs in 2004, costing them over $1 billion dollars in loan fees.
Pay stub RALs differ from a traditional RAL because they are offered earlier, before a taxpayer receives his W-2. Since a taxpayer cannot file a tax return without a W-2, pay stub RALs are made before the tax season officially starts and are based on the consumer's most recent pay stub.
Holiday RALs were made even earlier, during November and December. Both types of loans are offered by tax preparers, and are expected to be repaid from the proceeds of the consumer's tax refund.
In addition to added costs, pay stub and holiday RALs pose significant risks to consumers, because they are made based on estimated tax refunds before taxpayers receive their final tax information from a W-2. At the time that the pay stub RAL is made, for example, the tax preparer would not have any information if the Internal Revenue Service is planning to seize all or part of the taxpayer's refund to pay a child support or student loan debt. The taxpayer may have pre-tax deductions such as retirement contributions that are not accurately reflected on the taxpayer's final pay stub. A taxpayer might have other sources of income not reflected on his pay stub that reduce his refund, such as a second job, income from a 1099, or unemployment compensation.
So, then why are pay stub and holiday refund anticipation loans not a good idea? These loans carry large fees sometimes translating into triple digit annual percentage rates. Also, these loans must be paid back in a short period of time whether or not the tax refund is large enough to cover the loan and fees. This may cause the taxpayer even more financial despair.