Wall Street Journal, Thursday, May 29, 2003, p. A4

Retailers Are Cashing In On Tax Credit for the Poor

Retailers Help Prepare Earned-Income Claims But Steer Refunds Toward Loans, Purchases

By JOHN D. MCKINNON

NEW ORLEANS -- The Bush administration wants to make it more difficult for the working poor to apply for a tax credit that has kept millions of Americans above the poverty line. But for many of these people, hanging onto their tax refund is the real challenge.

From pawn shops to jewelers to auto dealers, merchants in poor neighborhoods are offering tax-preparation services in an effort to cash in on what has become the nation's biggest antipoverty program: the Earned Income Tax Credit.

Under the EITC, the Internal Revenue Service mails tax-refund checks to the working poor, even those who don't earn enough to pay any income tax. About 20 million families receive an average of $1,700 under the program. Households with incomes between about $10,500 and $13,000

receive the most -- $4,140 for 2002.

But critics say the program is rife with fraud and overpayment. And tax preparers may be as much of a problem as tax cheats. Overall, about 31% of returns filed by independent preparers contain errors, compared with about 23% for the national tax-preparation chains, according to one IRS study. Some retailers take advantage of customers, critics complain; others simply mess up.

In New Orleans, community activist Ronald Coleman is seeking to launch a campaign in July to convince low-income taxpayers not to turn to these outlets for help. Shortly before Mardi Gras, he and others handed out leaflets advertising a free tax service offered by a community group. Another group drove volunteer tax preparers from Tulane University in a Winnebago to housing projects. But the efforts didn't make enough of a difference. "This needs to be a year-long campaign," he says.

The IRS calculates that 30% of EITC benefits -- $8 billion or more annually -- is paid out erroneously. In response, Congress has regularly increased the documentation required of EITC filers. Now, the Bush administration wants them to preregister the children they plan to claim as dependents by providing the IRS with birth certificates. Congressional Democrats accuse the administration of singling out poor people, while ignoring wealthy taxpayers who also have high rates of fraud, such as self-employed businesspeople.

Merchants can profit in at least three ways from the EITC: by charging fees for tax help; by making extraordinarily high-interest bridge loans before a refund arrives; and by selling expensive products to customers flush with tax refunds. "You have a whole new group of preparers who have no experience with the tax system," says Nina Olson, the IRS's national taxpayer advocate. "Their goal for filing is to bring consumers through their door to sell them products and merchandise. ... It's just crazy."

Thanks to cheap software and tax advice from the IRS, merchants can expand into the tax-filing business with little training. Tax-prep services also cut deals with retailers, sometimes getting floor space, other times providing the service by fax.

Mid-Knight Tax Services in Hampton, Va., signed up 50 Virginia auto dealers this year, and plans to add mobile-home dealers and furniture stores next year. TaxMax, a Clearwater, Fla., division of publicly traded Canadian company Carbiz.com, has teamed with more than 1,100 auto dealers.

At participating dealerships, sales staff helped customers fill out taxes, then faxed the forms to TaxMax for electronic filing with the IRS. Customers paid between $150 and $200 for tax preparation, and obtained refund loans to use for automobile down payments. TaxMax arranged loans, at annualized interest rates of as much as 400%, for the two weeks it takes for tax refunds to arrive.

TaxMax's founder, Stan Heintz, says the service helps give low-income consumers "an opportunity to get into a car immediately." But his firm's Web site also emphasizes that dealers gain "control of the sale and the customer's refund."

A salesman at Bud Brady Ford in Cleveland was so anxious to get Nina Grove's business in 2001 that he drove the 19-year-old home to get a W-2 form, she says. Then he helped her fill out a tax questionnaire and file the return. She was entitled to a $3,119 EITC check.

Although Ms. Grove was unemployed at the time, she says the Ford salesman offered her an instant refund loan of almost $1,800 -- at an estimated annualized interest rate of 142.76% -- for the down payment on a $5,995 Mazda Protege. Her monthly payments were $340.

But the Mazda broke down, she says, as did a loaner car, which then was struck by another vehicle. When she went to pick up her $1,387 refund check a few days later, the dealership had kept all but $347 from her tax refund, to offset the damage to the loaner, she says.

Soon afterward, Ms. Grove defaulted on her car loan, and her Mazda was repossessed, leaving her with no refund and no car. Now she may even face a tax bill: When cars are repossessed, the car loans are canceled, and the IRS typically considers the cancellation as income. Ms. Grove is suing Bud Brady Ford to get $1,040 of her refund back.

A lawyer for the dealer says Ms. Grove's claim is baseless. Bud Brady Ford says legitimate charges reduced Ms. Grove's refund check, including insurance costs and a payment on her car loan. Ms. Grove's attorney, Ron Frederick, doesn't dispute most of those charges but says the dealership had no right to withhold about $395 that it took without her permission for repair of the loaner. "They don't get to be the judge and jury," he said.

The EITC was adopted in 1975 during the Ford administration and its payouts have grown under Republican and Democratic administrations. EITC payments now keep more than four million recipients above the federal poverty level each year, according to studies of census figures.

But the tax forms are so dauntingly complex -- EITC instructions run 53 pages -- that at least two-thirds of EITC recipients use tax preparers. Some preparers "just automatically sign up anyone who is low income," says Kristan Burgess, a lawyer at Camden Regional Legal Services Inc. in Bridgeton, N.J.

One of her clients, a 26-year-old Guatemalan landscaping worker, tells of going to a travel agency to have his taxes done three years ago. "If you borrow some dependents, you won't have to pay [taxes], you'll get a refund," the travel agent advised, according to the landscaper, who took the advice and falsely claimed two dependents. The travel agent prepared his return, seeking a total refund of about $3,500, but the IRS discovered the scam and didn't make the payment.

The landscape worker wasn't punished, Ms. Burgess says, though the IRS can bar individuals who participate in EITC scams from receiving the tax credit for years. As of Jan. 1, some 20,435 taxpayers were on a two-year ban, and an additional 879,215 taxpayers must provide extensive proof of future EITC claims, after the IRS denied their prior claims.