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Taxes and the Poor: Why do low-income families use paid tax preparers?

Many low-income families do not have to file federal income tax returns because they owe no tax, but not filing can cost them tax benefits such as the earned income tax credit (EITC). Those who do file often need help preparing their returns, which nearly always comes from a paid preparer. Getting that help-and associated services such as refund anticipation loans (RALs)-erodes the value of the EITC and other refundable credits for these families. That cost might be worth bearing if preparers help their clients claim tax benefits that otherwise might be missed, but evidence suggests that some families who use paid preparers and qualify for the EITC still fail to claim the credit. On the other hand, some preparers not only do inform their low-income clients of their EITC eligibility, but further help them by identifying nontax forms of assistance for which they might qualify, and some even assist in the application process.

  • A majority of low-income families that file tax returns receive help to do so. In 2002, two-thirds of families with income below twice the poverty line (about $36,500 for a couple with two children, for example) received help, and virtually all used paid preparers. Hispanic and African-American families and families with less than a college education were more likely than the average low-income family to receive help.
  • Using a paid preparer does not appear to make tax filers more aware of available tax benefits such as the EITC, but it does increase the likelihood that a filer who knows about the EITC will claim the credit. Roughly 70 percent of low-income tax filers reported knowing about the EITC in 2002, but among those who knew of the credit, about 80 percent of those using paid preparers actually claimed the credit, compared with 70 percent of those who filed on their own.
  • Some paid preparers help their low-income clients apply for nontax benefits. For example, one firm provided food stamp applications to all qualifying clients in the largest states, along with assistance in completing and filing the forms.
  • Low-income tax filers who use paid preparers can take advantage of refund anticipation loans (RALs), which are immediate cash loans from private lenders, backed by the tax refunds the borrowers have claimed on their prepared returns. RALs proliferated after 1999, when the Internal Revenue Service reinstituted the debt indicator program, which allows tax preparers to find out whether a filer’s tax refund will be redirected by the Internal Revenue Service to pay that filer’s debts. The National Consumer Law Center reports that in 2006 nearly 9 million taxpayers took out RALs. Although that number was down from the 2004 record high of 12.4 million, tax filers still paid nearly $1 billion in loan and other fees. Another 10.8 million taxpayers spent $324 million on other types of financial products to receive their refunds more quickly. A 2005 study found that RAL fees for a $2,000 refund typically ran between $35 and $115, resulting in effective annual interest rates between 40 percent and over 700 percent (because of the short duration of the actual loan).
  • EITC recipients are much more likely than nonrecipients to take out RALs. In 2006 nearly two-thirds of RALs went to tax filers claiming the EITC, even though they filed just one-sixth of all tax returns.
 
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