Aug. 5 (Bloomberg) -- The U.S. Internal Revenue Service said it will no longer help banks including HSBC Holdings Plc and Republic Bancorp Inc. underwrite tax refund loans that lawmakers and consumer groups say carry unfairly high interest rates.
The agency said it will withhold a digital indicator that tells banks when taxpayers qualify for refunds claimed on their tax forms and that a deposit is imminent. Tax preparation firms such as Jackson Hewitt Tax Service Inc., H&R Block Inc. and Liberty Tax Service advertise the loans as a way to get immediate cash.
“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,” IRS Commissioner Doug Shulman said in a statement. “We encourage taxpayers to use e-file with direct deposit so they can get their refunds in just a few days.”
The IRS’s move is part of a larger initiative announced this year to regulate the tax preparation industry for the first time in order to stop unscrupulous and untrained preparers from scamming taxpayers and the government. The agency has been concerned that refund loans encourage fraud, and the announcement today would force banks to assume more risk when making the loans.
‘Reflect the Risk’
“There’s no question” costs for the loans will rise if the IRS withholds the information, Steve Trager, president of Republic Bancorp, said in an interview. “Without the debt indicator the demand will remain, but the pricing will reflect the risk.”
Sixty-one percent of the 144 million individual tax returns filed are handled by paid preparers, according to IRS Taxpayer Advocate Nina Olson, the chief ombudsman for U.S. taxpayers. About 10 million Americans purchased refund loans in 2008, said a report by the Treasury Inspector General for Tax Administration.
The loans, which typically last between five and 14 days, are contracts between the taxpayer and the lending banks and can’t be rejected by the IRS. The debt indicator tells banks issuing the loans that the borrower’s tax refund won’t be withheld to satisfy government debts or unpaid child support.
Olson said today she has long been concerned the loans are marketed to taxpayers who don’t need them. She encouraged the IRS to find ways to let tax refunds be used to pay for tax preparation fees and to increase the use of debit cards and other programs to deliver refunds faster to Americans who don’t have bank accounts.
Chi Chi Wu, a lawyer for the National Consumer Law Center in Boston, said the group is pleased that the IRS is cracking down on companies that “siphon off hundreds of millions in taxpayers’ hard-earned money and federal benefits meant to lift the working poor out of poverty.”
London-based HSBC issues loans to customers of Kansas City, Missouri-based H&R Block, the nation’s largest tax preparer, under an agreement that runs through 2012. H&R Block said today the decision will reduce earnings by about 5 cents per share in 2011.
“Our real concern is how the increased lending risk will potentially hurt consumers with significantly lower loan approval rates and higher costs for the most vulnerable taxpayers,” Alan Bennett, the company’s president, said in a statement. H&R Block fell 40 cents, or 2.6 percent, to $15.01 at 4 p.m. in New York Stock Exchange composite trading.
Exiting Refund Business
HSBC spokesman Robert Sherman said the bank exited the tax-refund loan business in 2008 except for its partnership with H&R Block “with whom we have a contractual obligation.”
Republic Bancorp, based in Louisville, Kentucky, fell $6.34, or 24.8 percent, to $19.27, for the fourth-biggest decline on the Nasdaq Stock Market and the biggest drop among Nasdaq companies that began the day with market values of more than $500 million. The bank generated 63 percent of its revenue related to tax refund loans this year from customers of Jackson Hewitt, the second-largest preparer, and privately held Liberty, the third-largest.
Jackson Hewitt fell 17 cents, or 16 percent, to 89 cents in New York Stock Exchange trading. The company’s chief executive, Harry Buckley, criticized what he called a “unilateral” decision by the IRS and said consumers would pay more for loans.
Other sellers of the loans include Louisville-based River City Bank and the Santa Barbara Tax Products Group LLC. Both are privately held.
Advocacy groups such as the National Consumer Law Center and lawmakers including Senator Charles Schumer, a New York Democrat, have criticized the loans as predatory because they can carry triple-digit interest rates on an annualized basis. Some taxpayers who take the loans pay as much as 25 percent of their tax refund in fees to get their money a week earlier than they would have otherwise, the inspector general said.
The IRS decision “will go a long way toward protecting American taxpayers from having their income tax refunds reduced by these insidious loan products,” Schumer said today. Senate Finance Committee Chairman Max Baucus of Montana and Representatives John Lewis of Georgia and Xavier Becerra of California, all Democrats, also applauded the IRS’s move.
Trager said Republic Bancorp’s tax services constituted slightly less than half of its income last year. He said the bank sells two products: Refund anticipation loans, with average fees of about $58 on a typical $3,500 loan; and electronic checks that are paid when the IRS confirms the bank’s customers will receive a refund. Those checks cost about $30.
The charges are reasonable considering the “effort to distribute these checks to folks in a timely fashion,” Trager said.
John Hewitt, chief executive of Virginia Beach, Virginia-based Liberty Tax Service, called the IRS decision “disappointing” and said it would hurt consumers.
“This really isn’t the time to take financial options away from those who choose them, and more importantly need them,” he said. Liberty is privately held.
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