Refund Anticipation Loans and the Tax Gap

I. INTRODUCTION The tax gap is an issue drawing increased legislative and administrative attention. The IRS estimates that the gap, the difference between taxes that are legally owed and taxes that are paid on time, was $345 billion for tax year 2001. (1) Voluntary compliance is approximately 83.7%, and the IRS estimates that each percentage of noncompliance costs approximately $21 billion. (2) In the past Congress has admonished the IRS for failing to come up with a comprehensive plan for reducing the tax gap. (3) In 2007, the IRS and Treasury responded by releasing a report outlining the steps the IRS is taking to reduce the tax gap, and outlined the agency's comprehensive plan to attack the elements that contribute to the overall tax gap: nonfiling, underreporting and underpayment. (4) The increased agency and legislative attention on the tax gap coincides with a time of increasing budget deficits and the related governmental quest for increasing revenues without increasing the tax rates or expanding the tax base. (5) Looking for extra dollars from noncompliant taxpayers is less likely to generate political backlash than increasing taxes. Reducing the tax gap is largely a bipartisan rallying cry. (6) Though, as this Article reveals, efforts to reduce underreporting are not free of political risk, especially when targeted at well-heeled and organized parties likely to bear the costs of government efforts. This Article will look at one such effort: the IRS's attempt to reduce noncompliance associated with lower-income individuals seeking refund anticipation loans (RALs). RALs are loans secured by taxpayers' expected tax refunds, and they have become part of the blossoming tax return preparation industry. (7) Approximately fifty-six percent of RALs are associated with taxpayers who claim the earned income tax credit (EITC), (8) a refundable credit targeted to low- and moderate-income individuals. (9) The RAL lender will issue the refund amount to the taxpayer, less any tax preparation, filing, processing, and finance fees. The sum total of these fees can be quite high: from roughly $150 up to $500, depending on the preparer and lender. (l0) RALs have created a substantial market, with about $900 million in loan-related RAL fees being generated annually. (11) The presence of fees, and the existence of ancillary service or product providers at or in proximity to the return preparers, raises the question as to whether the allure of these fees is encouraging tax return preparers to act improperly and contribute to the compliance problems associated with returns associated with EITC-fueled refunds. (12) This Article argues that our general lack of understanding of how return preparers contribute to the decision to comply (or not comply) with our nation's tax laws limits the ability for policy makers to take effective administrative or legislative action aimed at reducing the tax gap associated with returns that are associated with RALs in general, and the EITC in particular. It will look at one such administrative effort, the Treasury's Advanced Notice of Proposed Rulemaking (ANPR), (13) issued in January 2008, which asked for guidance on whether the selling of RALs should be restricted due to such products potentially creating an incentive for preparers to fail to comply with due diligence requirements designed to ensure the accuracy of refund claims. (14) While I applaud the IRS's efforts to examine the relationship between incentive and noncompliance, (15) and while there may be sufficient non-tax policy reasons to further regulate such products, (16) I do not believe that there is sufficient evidence from a tax compliance perspective alone to take action that would effectively limit its use. The ANPR highlights the preparers' role in taxpayer compliance decisions, and it is possible that RALs contribute in some way to both taxpayer and practitioner decisions to fail to comply with internal revenue laws. …