Every year around this time millions of the working poor send their tax forms to the Internal Revenue Service, applying for an end-of-the-year bonus known as the earned income tax credit (EITC). For people struggling to support their families on salaries that typically hover around the poverty line, the couple thousand dollars they might receive is often counted on to clear up debts or make a necessary big purchase.
Expanded by President Clinton as a key component of his anti-poverty program, the EITC is a tax benefit designed to benefit low and moderate-income workers. For people struggling to make ends meet with low paying jobs, the EITC helps make work more attractive than welfare and provides an important income supplement. All told, around 20 million people receive the credit each year.
However, it looks like chunks of the credit aren't going to the working poor at all, but instead to behemoth tax-preparing agencies -- agencies that may not be being totally honest with the people who are paying them large fees to get the credits. H&R Block, one of the biggest agencies, has made one lawyer so mad that he's suing for false advertising. Others simply think the agencies and the banks that partner with them are unfairly profiting off the poor.
The EITC works like this: Workers fill out their tax forms and send them to the IRS. For those who are eligible for the EITC, the government sends them a check -- much like the tax refunds that others may receive. But accounting companies like H&R Block offer another option. They fill out the tax forms for people, charging them the standard fee, and then if they qualify for the credit, they offer what amounts to a short-term bank loan that allows people to get their EITC in just a few days. The catch is that the firms charge a hefty fee for that loan -- even though the period of the loan may be just over a week and a half.
These monetary quick fixes, formally known as refund anticipation loans, are very popular items at tax preparation companies, not only with people who are eligible for the EITC, but also with those who receive regular refunds. H&R Block estimates that this January alone the company arranged for 1.4 million of the loans.
The company contracts to provide these refund anticipation loans through a bank. The bank sets up an account for the tax refund, cuts the customer a check minus the fees, and is reimbursed when the IRS sends in the refund. In order to get one of these loans, the tax preparation company must file an electronic tax form with the IRS, which means the customer would have gotten the refund back in just two weeks anyway. At H&R Block, the fee for the quick refund ranges from $20 to $60, depending on how big the expected check from the IRS is. The EITC is crafted so that the neediest workers get the largest credit -- so the banks are profiting the most from the recipients with the least. And since the loan is short-term, the fee often represents annual percentage rates of over 100 percent.
The loan fee is not the only one. A commercial tax preparation service will typically charge around $85 to fill out the forms and another $25 to file them electronically. All together, that adds up to as much as $170.
To John Wancheck, the EITC campaign coordinator for the Center on Budget and Policy Priorities, a poor person shelling out $170 out of a couple thousand dollar credit is not money well spent, particularly when the IRS helps fund free tax preparation services for low-income workers. "When this person goes in to spend money to get a refund, he is spending money he doesn't have," Wancheck says.
Others question whether there is adequate explanation of the fact that customers can get their refund back quickly without the fast refund. In California, Karl Olson, a San Francisco attorney, filed suit against H&R Block, charging that the company engaged in false advertising practices. Between the long forms and small print, it is not clear people really understand they don't have to buy the loan, he says.
The H&R Block agents are "scripted to try and steer people into loans as the first option, without telling them they can get the refund in two weeks from IRS," Olson explains. The lawsuit, filed in 1997, might go to trial this May.
Others agree. Surveys of low-income workers show that many do not know that they are eligible for the EITC. Therefore, H&R Block and others may appear to be getting low-income workers free money. The workers -- many of whom know little about tax policy -- don't know that they can get the money without paying hefty fees.
"I would say it is likely that many people receiving these refund anticipation loans don't understand how high an interest rate they are paying," says Jeffrey Liebman, a professor at Harvard's Kennedy School of Government who studies the EITC. "On the other hand, these paid tax preparers probably increase the take up rate of the EITC because of their heavy advertising and presence in low income communities."
While he will not comment directly on the lawsuit, H&R Block spokesman Neil Getzlow says that customers sign an application that discloses what all the charges are. "A lot of clients prefer to get money back in a short amount of time. A lot of people need the money right away," Getzlow argues. "I did my taxes and I got one."
These quick loans are just one of a seemingly endless number of financial services targeted at low-income people that charge exorbitant rates and fees. For example, poor people often do not have bank accounts and will spend a good chunk of each paycheck getting it cashed at a check-cashing store. In Washington, D.C., one check-cashing outlet charges an extra fee to pay out a government check like a tax refund or a Social Security check, says Jeffrey S. Gold, a certified public accountant who coordinates a free tax assistance program. This practice is particularly objectionable because government checks pose the least risk; a check from the U.S. Treasury will never bounce.
Another problem is that low-income people often seek tax help not at big companies like H&R Block, but at "storefront" operations that might be less scrupulous or more prone to making errors. Nina Olson, who runs a Virginia legal aid clinic that helps low-income workers with tax cases before the IRS, says that more than half the problem returns her clinic deals with were prepared by somebody else. If there is a mistake in the form -- for example taking credit for a child who lives with another parent -- the person who filed the claim is on the hook for the credit they received, plus a penalty fee, plus interest.
"A lot of the time people will set up shop in a place like a check cashing store, just one person who sits there from February 1 to April 15. If you went back afterwards after running into problems with your taxes, that person wouldn't be there," she explains.
In New Mexico, car dealerships advertise that they will help people with their tax returns and then use the refund as a down payment on a car. These offers are very appealing to people who get the EITC, according to Veronika Fabian, who directs the consumer law division of a legal aid group near the Navajo Nation reservation. But people who screw up on their tax forms -- such as claiming dependents they aren't entitled to -- will end up having their tax refunds intercepted by the IRS. Then, the person not only loses the car but often ends up owing the IRS money, Fabian says.
Advocates for low-income taxpayers say the easiest solution to protect low-income people from these kind of dubious services would be to expand the amount of free clinics that help people with their taxes. While the IRS currently funds a program, providing staff to train volunteers, they need to put more money into the program, says Michael O'Connor, founder of several free tax preparation clinics in Illinois. Local groups need help in recruiting and supervising volunteers, as well as with advertising, so poor people will know they don't have to go to a commercial tax company.
