Tax refund advances could be especially appealing to taxpayers this year because of a federal rule that will delay refunds for filers claiming the earned income tax credit or the additional child tax credit. These filers tend to be lower-income Americans who like to complete their tax returns as early as possible – Jan. 23, 2017, was the first day taxpayers could file for 2016 taxes – so they can use their refund to pay their bills. But to help combat fraud and mistakes that have cost the Internal Revenue Service (IRS) substantial sums, the tax agency delayed refunds until Feb. 15 for early filers claiming these credits.
Tax refund advances, also called tax refund loans, are described as totally interest-free and fee-free loans of up to $1,300 that the three major tax preparation companies – H&R Block, Jackson Hewitt and Liberty Tax Service – are offering for a limited time this tax season to customers who are due a refund and who file their taxes in person at a participating location. These aren’t the same as the pricey tax refund anticipation loans offered a few years ago, which the government banned because of their high fees. The big draw of these new tax refund loans, besides being zero cost, is that they let taxpayers receive part of their refund from the tax prep company within as little as a few hours instead of waiting up to several weeks to receive their full refund from the IRS.
How Tax Refund Advances Benefit Tax Preparation Companies
Why offer totally free loans to tax prep customers? It’s to get them in the door and collect fees on other services. With fierce competition from less expensive do-it-yourself services, such as TurboTax, TaxAct, TaxSlayer and Credit Karma Tax, brick-and-mortar tax prep services need a way to distinguish themselves and regain market share. Refund loans are a way to offer something that tax prep software cannot.
The loans do not actually come from the tax prep companies themselves but from banks that work with them: MetaBank for H&R Block and Jackson Hewitt, and Republic Bank & Trust Company for Liberty Tax Service. When a customer signs up for one of these loans, the IRS sends the money to the financial institution associated with the tax preparation company, which then disburses the funds to the customer. When a taxpayer’s refund arrives, the tax prep company collects the loan funds it advanced, then remits the remaining refund to the customer. (For more, see Should You File an Early Tax Return?)
Tax prep companies are at risk of not getting repaid for their tax refund loans if the IRS calculates a lower refund than the tax preparer does, but they say they will not pursue borrowers for loans that can’t be repaid. The loans are not free for tax preparers to offer, but they can write off the costs as marketing expenses.
Perhaps most important, these loans are a way to get consumers to pay for tax preparation services, as they are only available to customers who pay to have their returns professionally prepared in person. Other services taxpayers can end up paying for once they’re in the door are refund transfer accounts that allow customers to finance tax preparation fees and the fees associated with prepaid debit cards on which customers can receive their loans and tax refunds. (For more, see 'Free' Tax Refund Loans: Are They Really Free?)
Alternatives to Tax Refund Loans
While refund loans themselves are free, the tax preparation associated with them can be expensive, and the fees may not be clear up front. In addition, some consumers may rack up high fees using the prepaid cards on which these funds are delivered, depending on how they use them. Taxpayers who want to save money should consider these alternatives.
- E-file your return and request direct deposit of your refund to your bank account or a low-fee prepaid card. (For more, see 3 Prepaid Debit Cards with No Monthly Fees.) Officially, you should allow 21 days to receive your refund, but direct deposit refunds will usually arrive in two weeks or less. Electronic returns are processed much faster than paper returns, often within 24 hours, and direct deposit gets money into your account faster than a mailed check. If you request a check, once it arrives you still have to deposit it in your bank account and wait for it to clear. Checks can also get lost or be stolen.
- Paper-file your return and request direct deposit or prepaid card deposit. Your refund will usually arrive within three weeks after your paper return is processed, which can take four weeks. This method is inexpensive but cumbersome and may be too slow for taxpayers who are relying on their refunds to make ends meet.
You can keep tabs on the status of your refund at https://www.irs.gov/refunds. You’ll need to know your Social Security number, filing status and exact refund amount.
If you need money faster than these options allow, consider borrowing possibilities such as personal loans, credit cards and even payday loans. We aren’t a huge fan of these options in general, because of their high interest rates, but sometimes they are the best choice. (For more see When Are Personal Loans a Good Idea?, Why a Credit Card Is Better Than a Payday Loan, 3 Tips for Using Payday Loans, Car Title Loans: Good Option for Fast Cash? and How a Cash Advance Works.)
Shop around to see what the least expensive choice will be for your situation. Paying a high annual percentage rate for a week or two may be less expensive than paying to have your taxes professionally prepared, especially if you also have to pay a fee to borrow the tax prep fee. Many low-income taxpayers can have their taxes prepared for free; there’s no need to pay if you qualify for help.
Alternatives to Paid Tax Prep Services
Avoiding the potentially high fees associated with getting your taxes professionally prepared can certainly help with your finances. Consider these options:
- The IRS’s Volunteer Income Tax Assistance program for taxpayers with incomes of $54,000 or less, taxpayers with disabilities and those who speak limited English. If you qualify for the program, you’ll get free basic income tax return preparation from an IRS-certified volunteer.
- The IRS’s Tax Counseling for the Elderly program uses IRS-certified volunteers who specialize in tax matters related to pensions and retirement issues. There is no age requirement, but the program is generally intended for those who are 60 or older.
- The IRS’s Free File Software is available to taxpayers whose income is $64,000 or less. (State returns may still incur a small fee.) Choose the software from a number of well-known companies, including TurboTax, H&R Block and TaxAct.
- Free 1040EZ form preparation, which is offered in stores by H&R Block. If you have a simple tax situation – for example, you don’t itemize your deductions on schedule A and don’t have self-employment income – you may be able to use this service.
The Bottom Line
The big three tax prep companies say that they have not raised their tax prep fees for 2016 filers and that they do not charge different fees based on whether a customer takes out a tax refund loan. But the New York Times has reported that “tax preparation prices are frequently opaque, and wildly variable.”
If you do choose to work with a tax prep company, ask for a detailed estimate of your final price up front and don’t let anyone pressure you into paying fees you can’t afford. After getting an estimate, you may wish to see what your other options are for preparing your taxes and borrowing money to tide you over until your refund arrives. Depending on your tax situation, you stand to save as much as a few hundred dollars. (For more, see 5 Smart Ways to Use Your Tax Refund.)