Despite the jitters felt in the market last week when the Internal Revenue Service said it was contemplating new restrictions on refund-anticipation loans, experts said the rule would not necessarily spell the end of such products.
For one thing, said David Williams, the IRS' director of electronic tax administration, the agency had no intention of banning the loans or even tax preparation companies' involvement in making them. It just wants to make sure the functions of selling the loans and preparing returns are separate so preparers have no incentive to falsify information, Mr. Williams said Friday.
Moreover, observers said that even if the IRS bars the use of information obtained in the return-preparation process for marketing financial products, companies that can offer alternatives might benefit. Hence, a crackdown on traditional RALs might give H&R Block Inc. one more reason to keep its thrift, something its chairman, Richard Breeden, has expressed mixed feelings about.
Also, the IRS could not stop banks or other financial firms with no connection to tax preparation companies from offering the loans.
The IRS announced Thursday that it was considering the regulations. The stocks of tax preparation companies like H&R Block and Jackson Hewitt Tax Service Inc. and of Pacific Capital Bancorp (which funds refund-anticipation loans for Jackson Hewitt) tanked that day, though on Friday Jackson Hewitt shares regained some ground.
Mr. Williams said the IRS has found "anecdotal evidence" that refund-anticipation loan providers promote tax fraud by encouraging consumers to inflate their estimated refunds. Consumer advocates have complained that tax preparers have incentives "to do bad things and cheat" to boost the size of RALs and hence the preparers' compensation, he said.
However, the agency has not concluded whether this is true, Mr. Williams said.
Last week's advance notice of proposed rulemaking was intended to collect information and start a dialogue about tax information shared during the RAL process, he said.
"We do not have the authority nor is it in our province to ban RALs," Mr. Williams said. One possible outcome of the rulemaking process, he said, would permit tax preparation outfits to continue offering RALs as long as they "separate the act of return from the act of getting a bank product."
"That doesn't mean the person sitting at the desk across the way or at some other location couldn't get your consent and determine your eligibility for a refund-anticipation loan," he said.
A spokesman for HSBC Holdings PLC, which funds refund-anticipation loans for H&R Block, said the London banking company had not reviewed the IRS' notice.
In a research note, Brent Christ, an analyst with Fox-Pitt Kelton Cochran Caronia Waller (USA) LLC, said an IRS ruling could have a big impact on Pacific Capital, which funds RALs for Jackson Hewitt, because more than half of its business comes from funding RALs. Pacific Capital pointed out in a press release Thursday that "the proposal is in the early stages of consideration and is subject to a 90-day written comment period," during which the Santa Barbara, Calif., company plans "to provide information regarding its efforts to implement best practices within the RAL industry to increase disclosure and transparency, reduce incidents of fraud, and lower the costs of RALs for consumers."
John Hewitt, the chief executive of Liberty Tax Service and a founder of Jackson Hewitt, said the IRS could not stop banks from offering refund loans to consumers. "The IRS cannot regulate someone going to a bank and asking for a loan on a refund. That's not their charter and I don't think they intend to do so."
In a research note published Thursday, Mark Sproule, an analyst with Thomas Weisel Partners Group in New York, wrote that "while not a perfect replacement," H&R Block's thrift could fund a substitute RAL product. Such an alternative "would not be based on tax returns but could require that refunds be directly deposited to accounts from the IRS."
Mr. Breeden, the dissident shareholder who became the chairman of H&R Block late last year, has said in the past that he wants the company to get out of banking. More recently, however, Mr. Breeden has called the thrift a strategic asset and said that if a regulatory capital requirement were lifted, it would be more economical for H&R Block to keep it.
In an e-mail, a spokesman for H&R Block said the company's "tax professionals are not compensated on the sale of ancillary products, so there is no incentive for them other than serving taxpayers' best interests."
