As tax preparation giant H&R Block Inc. branches into financial planning, it's boosting profits with a loan program that gets customers refunds faster but takes a big bite of the proceeds.
Block last year arranged "refund anticipation loans" for 4.5 million of its customers -- about one of every four individuals that turned to the company for tax help. As this year's tax filing season began, Block was already 18 percent ahead of last year's pace.
The loan fees frequently translate into interest rates exceeding 100 percent a year, helping Block collect a pretax profit of $51 on every $100 in revenue generated by the program last year.
This profit margin would be the envy of most businesses, but the refund loans have created legal and public relations headaches for Kansas City, Mo.-based Block.
Critics of the program liken Block to a loan shark that preys upon low-income households, immigrants and financially unsophisticated people. They say Block doesn't do enough to make it clear that the refund advance is really a loan that must be repaid even if the Internal Revenue Service disputes the tax return or part of the money is siphoned away to pay for outstanding child support, student loans or other liens.
"It's an unconscionable scheme. They are intentionally out to milk these people," said Houston attorney Edward M. Carstarphen, who is trying to pursue a class-action lawsuit against Block.
Offering what they want
Block denies any wrongdoing and says the refund program simply responds to customer demand. The loans "are extremely popular," said Block spokeswoman Denise Sposato. "We are just trying to offer our clients something they want."
Block and its lending partner in the program, Household Bank, tried to mute the criticism in 2000 by paying a $25 million settlement of a class-action lawsuit. The settlement is supposed to refund up to $15 in loan fees to as many as 1.67 million customers.
Carstarphen and several other attorneys around the country are seeking to overturn the settlement, contending the penalties against Block and Household should be more severe. A federal judge in Chicago heard oral arguments in February on the appeal; if the appeal is sustained, it will revive class-action suits that were effectively killed by the earlier settlement.
Under Block's program, a customer owed a tax refund can receive most of the money in two to three business days with a loan from Household.
To qualify for the advance, the taxpayer must agree to pay up to $40 to file the return electronically and pay a loan processing fee of up to $89.95. This year, Block and Household are offering same-day refund loans for an additional $10 fee. All fees are deducted from the refund, which the customer agrees to have electronically deposited into an account set up by Household and Block.
Household pays Block a $9 referral fee for each refund loan. Critics describe the fee as a "kickback" that encourages Block's preparers to peddle the refund loans even when they aren't in customers' best interests.
Block also retains up to a 49.9 percent interest in the loans, assuring that the company adheres to a federal law that prohibits tax preparers from making directly issuing refund advances to their customers. The law is designed to prevent collusion between tax preparers and taxpayers.
Similar programs elsewhere
Similar refund loan programs are offered by other tax preparers, including Jackson Hewitt, and banks, including Santa Barbara Bank & Trust and Bank One Corp., but Block's partnership with Household is by far the largest. An estimated 10.8 million taxpayers take out loans against their refunds annually, based on an analysis of Internal Revenue Service data by the National Consumer Law Center.
In Chinle, Ariz., many of Block's customers are Navajo Indians who don't understand that the refund advances are really loans, said Leslie McLean, an accountant at DNA People's Legal Services, which offers aid to low-income households.
Julia Denetsosie of Kayenta, Ariz. said she didn't know what she was getting into when she signed up for a $5,000 refund loan after Block prepared her 1999 tax return.
Her refund was based largely on the Earned Income Tax Credit a Block preparer claimed on her behalf. The IRS disallowed the claim after she had already spent most of the refund loan amount, leaving her on the hook for a debt that she is still struggling to repay.
"I didn't even know it was a loan," said Denetsosie, 36. "I think they are definitely trying to take advantage of people."
Block makes it "as clear as possible" the advance is a loan in the documents all borrowers sign, Sposato said.
Block last year recorded pretax earnings of $68 million on refund loan revenue of $133.7 million, a 51 percent profit margin. Block's overall pretax profit totaled $473.1 million on revenue of $3 billion, a margin of roughly 16 percent.
The refund loan program performed even better in Block's most recently completed quarter ending in January, which included the start of tax filing season. The company reported pretax earnings of $17.1 million on $30.1 million revenue from refund loans, a 57 percent margin.
In January, the refund loan fee averaged $76.19, a 3 percent increase from last year, according to Block's filings with the Securities and Exchange Commission.
The difference between getting an advance through Block and waiting for the government to issue an electronic refund is about 10 days. Based on that gap, the $76.19 fee translates into an annualized interest rate of nearly 140 percent on a $2,000 loan, which is close to the average refund returned to taxpayers through March 8, according to the Internal Revenue Service.
At that interest rate, cash-strapped taxpayers are better off drawing a cash advance from a bank credit card and repaying the money when the full refund arrives from the IRS, said Chi Chi Wu, a staff attorney for the National Consumer Law Center, which studies issues affecting low-income households.
"We think (refund loans) ought to be banned or the interest rates should be capped at 36 percent," Wu said.
Block believes it's unfair to state its loan processing fee as an annualized interest rate. "It's a one-time fee -- sort of like paying $3 in ATM fees to withdraw $20," Sposato said.
On The Net
H&R Block Inc.: www.hrblock.com
National Consumer Law Center's report on refund anticipation loans: www.consumerlaw.org