The IRS has announced that it will no longer provide the debt indicator as part of the standard acknowledgement during the e-filing process.
Partnerships with Industry
During the late 1980s, in the early days of e-filing, the IRS provided what was known as a Direct Deposit Indicator (DDI). The DDI almost guaranteed that a taxpayer’s refund would be deposited in agreement with the amount filed. The purpose of the DDI was to promote e-filing; as a result of the partnership between the IRS and industry, e-filing by paid professionals significantly increased throughout the early ’90s. Since most returns e-filed at the time were associated with a refund loan, the DDI became an essential underwriting tool for banks that provided loans to taxpayers. It allowed the banks to reduce losses and keep prices low; prior to 1994, loan prices remained in the $30 range.
The Elimination of the DDI
In 1995 the IRS announced that it would no longer provide the DDI. As a result, banks shifted their underwriting criteria and pricing to allow for additional risk, causing the cost of Refund Anticipation Loans (RAL) to double. For the first—and only—time in the history of e-filing, the total returns e-filed decreased.
In 2002, as part of the requirements associated with the laws on collection of government debts, the IRS began to provide a Debt Indicator, or “DI.” While not the same thing as the DDI, the DI served as required notice to a taxpayer before a government (FMS) debt was withheld from their tax refund. The DI was also provided as part of the acknowledgment process during e-filing of a tax return, allowing the paid preparer to inform the taxpayer of the offset as part of their tax-preparation services.
Like the DDI, the DI was built into bank underwriting to provide refund loans. APRs went from over 100% to around 36% over the next few years, making refund loans more widely available to lower-income individuals.
Pressure from “Consumer” Groups
Watchdog organizations began rallying against the income tax industry early on. They felt that the complexity of the tax preparation process required the average taxpayer to utilize the services of a paid tax professional. With the DDI, and now the DI, consumer groups attacked tax preparers' industry partners as well: Banks providing loans were attacked as predatory lenders, and software companies were accused of charging additional dollars to "those who could least afford it." Solutions such as streamlining the tax code, or simplifying refundable credits, were never considered as viable alternatives to the perceived problem.
Fast-forward to August 2010: The IRS removes the DI from the acknowledgment process. The IRS will continue to provide the DI to taxpayers via the “Where’s My Refund” site, which has historically posted taxpayer acknowledgement data, generally about a week after a return is filed. The timing will preclude lending institutions from using the DI as an underwriting tool and will prevent tax professionals from informing their clients of an offset to their refund.
Banks that provide refund loans today have indicated they intend to continue to do so. However, the price of RALs will go up, the amount of the average loan will go down, and the criteria used to approve a loan will limit the number of products available to taxpayers.
The IRS has also indicated it is considering options for taxpayers to opt to send a part of their refund directly to their tax preparer; however, it wants to limit the price that can be charged for tax preparation when using this payment option. That price would be limited to a “reasonable” amount per the IRS.
Bottom line: Will these developments hinder the tax professional industry going forward? For example, will CPAs who charge more per hour than a large franchise be considered “unfair” or “taking advantage” of the taxpayer—not as providing a valuable service at a fair price?