How the Tax-Prep Industry Takes Advantage of Low-Income Filers

A new report finds that some Americans are giving away nearly 25 percent of their refund for services they could get for free.

A woman advertises for a tax preparation company. (Rick Wilking / Reuters)

The Earned Income Tax Credit program has become one of the largest national anti-poverty programs in the country, distributing about $67 billion to around 28 million low-income workers and their families. By that measure, it may seem the EITC, implemented in 1975, is a success. But a recent study from Johns Hopkins finds that the dubious practices of some tax preparers mean that many families are losing a sizeable chunk of their annual credit to tax professionals who, aware of how much money was in play, didn't hesitate to charge qualifying families excessive amounts for help filing.

And this isn’t the first time the practices of tax preparers have come under fire when it comes to the handling of EITC filers. A study from the Brookings Institution and the Progressive Policy Institute also had similar conclusions nearly 15 years ago.

The EITC provides a refund to households with low earned income for the year (where people did in fact work, but didn’t make much). The tax credit generally goes to families with children and earnings that don’t surpass $53,300 (depending on household size) and single adults whose incomes fall below $14,800. In recent years the average refund has been between $2,000 and $3,000.

According to the study, tax preparers, particularly storefront chains, focus on communities with a high population of low-earners that are eligible for the sizeable EITC refunds. These companies heavily promote their services, centering their ads on these types of tax filings, which require filling out short, but tricky documentation.

This publicity has the effect of obscuring the fact that those seeking the credit can file their claims for free, either on their own or through alternate services that provide tax assistance to low-earning households. In fact, some of the same services that charge these high rates for in-person assistance also provide software that would allow the same individuals to file for less. According to Paul Weinstein, one of the study’s authors, EITC filers in most places could have their taxes prepared for less than $100, either by using software or by seeking out preparers that don’t charge higher fees.

Nationally, the average amount that Americans spend on tax preparation services is around $275, said Weinstein. The authors conducted a very informal survey of storefront tax operations, where customers can simply walk in and have employees input their tax information. They went to storefront tax operations in two cities and presented each tax professional with identical information, then noted the price. They found that EITC filers would have spent between $309 and $509 in Washington D.C., and Baltimore, which accounted for between 13 percent and 21 percent of the total tax return. That’s well above the averages quoted in the annual reports of major chains like H&R Block and Liberty, which fell below $200 according to the report.

In addition to the marketing, another reason that even low-earners are willing outsource their tax preparation to third parties that charge such high fees is peace of mind and a sense of being safeguarded. “People find it convenient and they are intimidated by the complexity,” Weinstein added. “They're not necessarily comfortable dealing with the IRS and they believe having a third party do their taxes protects them.” This dynamic appeals to most Americans who fear the ramifications of IRS audits and massive bills, but it’s especially alluring for those who may have limited education and rely heavily on their refund for basic necessities.

Despite the promise of accuracy, the record for tax preparers appears to be mixed. Last year, a Government Accountability Office investigation of all professionally prepared taxes found that 60 percent contained errors. For EITC filers using professional services, government studies have found that the rate is significantly higher, between 89 and 94 percent. And those guarantees about accuracy and protection? They’re a bit overblown, Weinstein says. “Yes they are saying, ‘We'll redo it if we get it wrong,’ but if you owe more in taxes you're still going to have to pay and pay the penalties.”

A statement from H&R Block called the study “biased” and a “competitive attack.” The other tax preparers mentioned in the study have not responded to a request for comment.

Nevertheless, potentially siphoning up to 25 percent out of recipients pockets certainly wasn’t the original intent of the tax credit. And the loss of such a significant chunk of an annual windfall is a bigger problem than one might think. “Typically families use the EITC to pay off outstanding debt or to make an important purchase they've been waiting on the whole year,” Weinstein says. “For others, this is their forced savings plan.”

The problems with preparers, errors, and complexity is detrimental for other reasons too, since it can threaten the legitimacy of the program as a whole. One of the most common criticisms of social safety nets in the U.S. has been a caricature that they enable people to laze about while taking money from other hard-working, tax-paying Americans. While the EITC’s work requirement already rubs against that argument, the high error rates help provide fodder for those who say that the program isn’t working and that it allows for rampant fraud and abuses. And some critics feel that the notion of a guaranteed refund is fundamentally flawed anyway, especially for those who contribute so little to the tax base. In 2011, Texas Senator John Cornyn remarked, “To show how out of whack things have gotten, 30 percent of American households actually made money from the tax system by way of refundable tax credits—the Earned Income Tax Credit, among others.”

Weinstein says that critics of the EITC are off base, but that fixing some of the problems these filers run into could help both American families and the program itself. He suggests allowing the IRS to finally put competency exams in place for paid tax preparers who aren’t lawyers or Certified Public Accountants (CPAs), ensuring that they have enough training and knowledge to accurately complete tax forms—which could help mitigate the error rate. And he wants the government to invest more in marketing free and low-cost tax filing assistance programs, like the Volunteer Tax Assistance Program (VITA) which provides services who filers whose income falls below the $62,000 threshold. He also wants overall tax reform, but says he’s not holding his breath. Instead, he thinks simplifying the EITC process specifically could increase accuracy and decrease the appeal of costly third-party assistance.

Any of these changes would help Weinstein told me, though he doubts the country will ever successfully eliminate all predatory practices when it comes to low-income Americans and tax preparation.