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These tax-time refund offers should be avoided

You plan on getting a tax refund, but you don’t have the money to pay for the tax-preparation service. No problem, just sign up for a Refund Anticipation Check (RAC) and that charge will be deducted from your refund when you get it.

On its website, H & R Block describes a RAC as “a quick and convenient way to get all the money you deserve without having to pay upfront.”

Here’s how it works. The customer gets a temporary bank account where the IRS can direct deposit the refund. When the money arrives, the bank issues a check or prepaid debit card, minus the tax preparation charge, and closes the account.

Banks typically charge about $30 to $35 for this service. And for consumer advocates, that’s the rub.

“With a RAC you pay a fee to finance the expense of tax preparation, and we don’t think that’s a smart idea,” said Tom Feltner, director or financial services for the Consumer Federation of America. “We always warn people to be wary of financial products that are sold alongside tax preparation.”

That short-term loan turns out to be fairly expensive.  If you pay $30 to defer payment of a $200 tax preparation bill for 3 weeks, the APR on that loan is equivalent to 260 percent.

Most importantly, there is no speed advantage to a RAC.

“It’s not any faster than filing your return electronically and getting a direct deposit into your own bank account or into a prepaid debit card that you already have,” said Chi Chi Wu, staff attorney at the National Consumer Law Center (NCLC). “The only advantage is that you have the tax preparation fee deducted from your refund.”

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RACs have been around for years, but they’re growing in popularity. NCLC estimates that about 18.4 million taxpayers received a RAC in 2011, up from 14.6 million the year before and 12.9 in 2009.

The Refund Anticipation Check has replaced the Refund Anticipation Loan (RAL) as the add-on product pitched to taxpayers squeezed for cash or who do not have a bank account for direct deposit.

RALs, which give the customer an immediate refund, have been widely criticized by consumer advocates because of the high cost. Most banks no longer offer them.  RALs should be nearly gone from the marketplace by the end of this year.

Arkansas Attorney General Dustin McDaniel recently issued a Consumer Alert about the pitfalls of both RALs and RACs.

"We would encourage consumers to think twice before paying the excessive fees and interest associated with borrowing money that already belongs to them, anyway," he said.

Watch out for add-on fees
If after know all this, you do opt for a RAC, be on guard for extra fees added by the tax preparer. These fees are in addition to the bank charge ($30 to $35) and the cost of tax preparation.

“They can be expensive,” warned NCLC’s Chi Chi Wu. “We’ve done some secret shopper tests and found that some of these junk fees can be anywhere from $25 to several hundred dollars.”

Wu told me they’ve heard about people getting signed up for Refund Anticipation Checks unknowingly. The preparer either adds it automatically or refers to it as “direct deposit” instead of a RAC, which can be confusing.

“If the preparer asks how you would like your refund delivered, specifically ask about the fees associated with various methods,” Wu advised.

Why pay for tax preparation when you may be able to get free?
The IRS offers free preparation programs run by volunteers for low-income and elderly taxpayers. The Volunteer Income Tax Assistance (VITA) program is for those who earn $51,000 a year or less. The Tax Counseling for the Elderly (TCE) program is open to anyone, with priority given to those 60 and older.

The AARP Foundation Tax- Aide program provides free tax preparation for low-to moderate-income taxpayers (especially those 60 and older) at nearly 6,000 locations nationwide.

The IRS Free File program is available to any taxpayer who has an adjusted gross income of less than $57,000. You can prepare your return and file it online for free, giving you the quickest refund possible.

The bottom line
You’d be smart to avoid Refund Anticipation products of any kind.

If you have a bank account and you can afford to pay for the tax preparation out of pocket, have your refund directly deposited into that bank account. You’ll get the money just as quickly without paying any kind of service fee.

If you qualify for free tax preparation or filing, it would be silly not to go that route.

Finally, if you don’t have a bank account and are expecting a refund, now would be a good time to open a savings account and start building a nest egg.

More information

National Consumer Law Center: Avoid Tax-Time Refund Products

Consumer Reports: Don't be tempted by tax refund anticipation loans or checks

Herb Weisbaum is The ConsumerMan. Follow him on Facebook and Twitter or visit The ConsumerMan website.