Why do low-income families use tax preparers?
Many low-income families owe no income tax but still must file to receive refundable tax credits, including the earned income tax credit (EITC). Those who do file often need help, which nearly always comes from a paid preparer. The cost of that help erodes the net value of the EITC and other refundable credits. That cost might be worth bearing if preparers helped their clients claim tax benefits that otherwise might be missed, but many don’t.
Tax preparation for low-income families
Most people fill out their tax returns with assistance from paid preparers. In 2008, 57.8 percent of all returns were completed this way. That proportion is slightly lower for lower-income families, 55.8 percent for workers with adjusted gross incomes below $30,000 (table 1). A very small proportion of low-income families reported using Volunteer Income Tax Assistance (VITA) clinics.
Do Paid Preparers Fill Out More Accurate Returns?
Except in a handful of states, paid preparers are not regulated. The Government Accountability Office (GAO) found that returns completed by preparers were not more accurate than self-prepared returns and included errors in calculating a tax filer’s EITC – a problem specific to low- and moderate-income families.
In a small sampling performed by the GAO, only 2 of 19 returns showed the correct refund amount. On 13 tax returns in the sample, preparers overestimated the total refund by $100 or more (GAO 2014). A larger-scale study of IRS data showed that paid preparers had a higher estimated error rate—60 percent—than returns prepared by taxpayers themselves. Some of these errors are made by the preparer; some are the result of the taxpayer providing incorrect or incomplete information (GAO 2014).
These latter results were not limited to low-income families’ returns. When it comes to returns with the EITC, a recent study showed that unenrolled return preparers were more likely to make errors than other paid preparers. An unenrolled return preparer is someone other than an attorney, CPA, or an enrolled agent—agents licensed by the IRS. Unenrolled preparers completed 43 percent of the EITC returns made by paid preparers, while national tax preparation firms completed 35 percent of these returns (Internal Revenue Service 2014).
One clear benefit of paid preparation: an earlier study of low-income workers showed that if someone already knows about the EITC, they are more likely to receive it if they use a paid preparer to manage the paperwork than if they fill out their returns themselves (Maag 2005). Moreover, some preparers not only inform their low-income clients of their EITC eligibility, but further help them by identifying other forms of assistance for which they might qualify, and some even assist in the application process.
Use of Refund Anticipation Loans and Refund Anticipation Checks
Prior to 2012, low-income tax filers who used paid preparers could get their tax refunds faster with a refund anticipation loan (RAL). RALs were relatively high-cost immediate cash loans from private lenders, backed by the tax refunds the borrowers claimed on their prepared returns. RALs proliferated after 1999 when the IRS reinstituted the debt indicator program, which disclosed whether a tax refund would be redirected by the Internal Revenue Service to pay debts.
The IRS has since discontinued use of the debt indicator, essentially eliminating the RAL market. However, most consumers who formerly received a RAL now appear to be using a similar product, the refund anticipation check (RAC). The RAC appears to cost less than the RAL but it can still be quite expensive. RACs are temporary bank accounts opened by paid preparers, where tax filers direct their refunds. Tax filers are allowed to pay fees out of their RACs. When the IRS deposits the refund, the paid preparer subtracts fees from the account, and then the tax filer can access the remainder.
In 2014, the National Consumer Law Center reported that more than 21 million consumers obtained RACs. Unlike RALs, RACs do not allow consumers faster access to anticipated refunds (Wu 2015). The vast majority of RAC consumers—about 83 percent—have low incomes. In fact, about half are EITC recipients (Wu 2015).
Internal Revenue Service. 2008 Statistics of Income Public Use File.
Berube, Alan. 2006. “The New Safety Net: How the Tax Code Helped Low-Income Working Families During the Early 2000s.” Washington, DC: Brookings Institution.
GAO (Government Accountability Office). 2014. “Paid Tax Return Preparers: In a Limited Study, Preparers Made Significant Errors.” Testimony of James R. McTigue, Jr., Director of Strategic Issues, before the Senate Committee on Finance, Washington, DC, April 8.
Internal Revenue Service. 2014. “Compliance Estimates for the Earned Income Tax Credit Claimed on 2006-2008 Returns.” Research, Analysis and Statistics Report 5162. Washington, DC: Internal Revenue Service.
Maag, Elaine. 2005. “Paying the Price: Low-Income Parents and the Use of Paid Tax Preparers.” New Federalism: National Survey of America's Families Report B-64. Washington, DC: Urban-Brookings Tax Policy Center.
Wu, Chi Chi. 2015. “Taxpayer Beware: Unregulated Tax Preparers and Tax-Time Financial Products Put Taxpayers at Risk.” Washington, DC: National Consumer Law Center.