It’s tempting. Sign a form, pay a fee and walk out with the cash Uncle Sam owes you. But tax-refund advances, which are actually loans, often come with interest rates that would embarrass loan sharks.

Millions of Americans look forward to tax season. They’re getting refunds. And many desperately need that check from the Internal Revenue Service.

In fact, many are so cash-strapped they don’t even wait for Uncle Sam. They turn instead to refund anticipation loans, or “rapid refund” in the industry parlance.

You’ve seen the ads. Simply sign a form with your tax preparer when filing your taxes, pay a fee of between $50 and $200 (that is 1% to 4% — I’ve seen many cases on small refunds with fees as high as 33%) and walk out with up to $5,000 cash against your coming refund check.

What you may not notice is the exorbitant annual percentage rate on that loan. But consumer groups have. They say these short-term, high-interest loans prey on the very people who can least afford them.

Critics of refund loans, as the loans are commonly known, point to the disparity between the tax advances and other credit offerings aimed at wealthier customers.

In the market for a new Lexus? Some multiyear loans for the luxury car were at zero-percent APR last year. Major tax preparers, such as H&R Block and Jackson Hewitt, meanwhile, charge between 67% to 774% APR for what amounts to a ten-day (at the longest) loan secured by your income tax return. The IRS further exacerbates the risk with its Debt Indicator Service (interesting — DIS — they must have stayed up for a week to come up with that one), alerting lenders to any claims (child support, unpaid federal student loan, outstanding taxes, etc.) against refund-loan applicants’ refunds.

On average, the lender gets its money from IRS in a week. A 1% fee for advancing your refund is actually an APR of 52.3449%. A 4% fee for advanding your refund is an APR of 216.4680%. You can use the Financial Calculator to check these figures out for yourself. Enter the refund that you are due from IRS in the “Level payment” of the Loans and Annuities calculator. Choose “Weekly” as the “Payment plan” value. In the “Initial principal” field enter the refund amount minus the fee you paid. Enter the numeral “1” (one) in the “No. of payments” field. Then, press the “Go” button to the left of “Loan’s annual rate.” You’ll be amazed to see the gigantic annual percentage rate you are actually paying. For example, suppose your tax preparation company charges you $225 to give you a “rapid refund” from IRS for a refund that is mostly your Earned Income Credit; the whole refund is $2,135 (this is a real case from my own case files — I won’t name the company involved). Your tax preparer gives you a check for $1,910 ($2,135 — $225). Your fee is 10.54% of the refund you were due, but the annual rate of return to your tax preparation company is a hellacious 612.565%!!

“It’s an outrageous rate for a really short-term loan which, by the way, is a zero risk to the lender, and it’s a zero risk because the IRS tells them in advance who is going to present a risk,” says Chi Chi Wu, staff attorney for the National Consumer Law Center. “Yes, it seems like a small amount of money and it would be if this were a one- or two-year loan, but it’s not. It’s a 10-day loan at the longest. That makes all the difference in the world.”

Sidestepping Statutory Interest Rate Caps

Just how do refund loan lenders get away with the high interest rates? Major tax preparers circumvent state usury rate caps (usually 36% APR or less) by partnering with banks chartered in states such as South Dakota and Delaware that have no caps. The 500-pound gorilla in the refund loan market is Household Bank, a partner with H&R Block among others.

But tax preparers are by no means the only refund-loan vendors.

Car dealers apply anticipated refunds toward auto down payments, joining check-cashing services, retailers, Internet sites and tax-software companies in promoting the loans as tax-season incentives to get more business — and make more money.

And it’s not always someone needing rent money who signs up for a refund loan. Car dealers employ the tax-advance loan concept because it pulls in buyers. Tax preparers say the loans also are popular ways for impatient taxpayers to pay for vacations, large appliances or home entertainment systems.

A Vicious Cycle

But refund-loan opponents contend that the biggest market for the loans is the working poor, just like my client whose situation I gave above as a real world example.

A report by the NCLC and the Consumer Federation of America, found that 4.32 million taxpayers, or about 40% of the 12 million refund loan customers in 2000, were families who received the Earned Income Tax Credit, the largest federal poverty assistance program.

These taxpayers are typically caught in the vicious cycle of circumstances that enable refund-loan providers to take a loan-shark-size bite out of the filers’ limited funds. Although their income may be minimal, the paperwork to receive the EITC is not. The tax forms and computations are especially challenging for those facing education, literacy and language barriers.

As a result, EITC-eligible filers frequently use a commercial tax preparation company. Once there, many opt for a refund loan to pay their tax-preparation fees, never realizing that it is a loan and not the refund itself.

In addition, many of these same taxpayers are without commercial bank accounts. A refund loan creates a one-time-use account into which the taxpayer’s refund is directly deposited by the IRS — and from which the lender takes its share before delivering the balance to the customer.

Making the Poor Pay More

“There are people who don’t get their full tax refund and if you are in that small percentage, now you’re in a lot of trouble because you’ve borrowed $2,000, $3,000, $4,000 and you can’t pay it back,” says Wu. “These are people who are living paycheck to paycheck.”

The CFA-NCLC study estimates that refund loans drained about $324 million from the EITC (Earned Income Tax Credit) program in 2002. Based on national averages, an EITC borrower could expect to pay $267 in fees for refund loan, electronic filing, check cashing and tax preparation fees to obtain a $1,600 refund.

“This is the only federal poverty program where the cost of distribution is imposed on the recipients,” says Jean Ann Fox, CFA director of consumer protection. “It’s very cheap for the government to distribute the EITC because they have put the applicants in the position of having to pay a commercial entity to help them apply for it.”

It has even been suggested that the IRS itself has been a passive advocate of refund loans.

Under a mandate from Congress, the IRS must expand electronic filing to 80 percent of filed returns by 2007. To further this process, this tax season the IRS partnered with commercial preparers to provide free electronic tax preparation and filing.

Since most of the companies in the program, known as the Free File Alliance, market refund loans, consumer groups urged the IRS to offer direct e-filing through its Web site or at least prohibit its commercial partners from offering refund loans. It did neither.

In announcing the e-filing partnership, the IRS deferred to private industry’s “expertise and experience” in electronic tax services. As for the loans, IRS Director of Electronic Tax Administration Terry Lutes said the agency has never endorsed or encouraged refund loans.

“They have a long history and existed before e-filing,” said Lutes. “But the point we want to emphasize is that companies that do offer them cannot advertise them as refunds; they are loans. We emphasize that e-filing gets you the money fast. Refund loans may beat it, but by just a few days.”

Refund loan opponents view the government position skeptically.

“There is no evidence that Congress has any concern about the entire area of predatory financial services that strips wealth from their constituents that can least afford to lose any money to the sharks,” says Fox. “The IRS has a huge incentive to cast a blind eye to what is going on in the refund loan market.”

In addition, class action suits have cropped up around the country claiming refund loan lenders use deceptive marketing, nondisclosure and high-pressure sales techniques. To settle a case in Texas concerning its refund loan disclosures and fee structure, H&R Block last November shelled out $262 million, a figure consumer advocates consider small potatoes. According to the CFA-NCLC study, Block, the nation’s largest tax preparer, made $133.7 million in gross revenue and $68 million in net profits on refund loans in 2001 alone.

A Loan Past its Prime?

Some say the refund loan is living on borrowed time. They see the industry vanishing as technology and e-filing cut the time it takes for the IRS to get your refund to you.

“The IRS is claiming they will be able to turn around refunds in two or three days in a few years if you file electronically,” says Wu.

“These are ways to meet the needs of consumers who are eligible for the Earned Income Tax Credit without them having to spend hundreds of dollars to get their taxes prepared and file for a loan in order to have the out-of-pocket money to get their taxes done,” says Fox.

“We need to break the cycle somewhere until the IRS figures out a way to get everybody their refund immediately.”