Jackson-Hewitt Goes Bankrupt; or, That's Your Business Model?!?

Jackson Hewitt, the nation’s second largest paid tax preparation chain, filed for Chapter 11 bankruptcy on Tuesday. The tax giant’s stock had been free falling since February when the IRS announced it would end the debt indicator, an administrative flag from the IRS that helped banks to make tax refund anticipation loans (RALs). It got worse when several of the smaller, regional banks were told by the FDIC that they were not financially stable enough to sell tax loans.

It is likely that Jackson Hewitt, with new private capital infusions, will emerge from bankruptcy in some form. But at the core of their downturn are some serious questions. First and foremost, are tax loans so important to paid preparation chains that they cannot flourish without the product? The National Consumer Law Center (NCLC) and Consumer Federation of America’s annual report noted a sizable decrease in total tax loans but writes that at least $600 million in loans were sold to more than 7 million people. This doesn’t include tax refund checks (RACs), audit protection, and other charges. Author Gary Rivlin, Broke USA, was amazed at how much profit and tax loan selling could go on in just a one or two month time period as he toured the shops.

The majority of Jackson Hewitt’s RAL customers are Earned Income Tax Credit (EITC) recipients, the nation’s largest poverty relief program. In fact, roughly one-quarter of their revenue came from RALs. The EITC has a long history of being an effective, refundable tax credit that boosts the income of working families with children. Most families will receive around $2,000 in EITC with the maximum refund being over $5,000 for someone with three children. What Jackson Hewitt and other tax preparers quickly realized is that working families couldn’t afford to pay upfront costs for tax preparation and they could hardly wait weeks for the tax refund. Over the years, it became very apparent that tax operations were really pushing tax loans hard and this latest episode shows us how integral they are to the model. From our research in Ohio, we found that more than 60% of all RALs went to EITC claimants and just under half of the EITC claimants who used paid preparation purchased RALs. When RACs are factored in, the numbers skyrocket. In other words, if you were in a paid tax preparation chain and got the EITC, you were getting a loan (RAL) or a check (RAC). The latest trends are higher tax preparation costs and the use of RACs to finance the cost of preparation.

Tax time is an excellent opportunity for building and protecting income. The current paid preparation chain model does not follow an asset building model, which is unfortunate. It essentially privatizes the EITC, diluting a needed public benefit (editor's note: see David Stoesz' paper Quick Credit). It also provides perverse incentive for preparers to load up returns since the total cost is based on the number of credits, forms, and total return. Shoppers for the NCLC and our organization find that paid preparation with fees and loans can easily dilute 20% of a family’s total tax return. That could be hundreds of dollars back to the family. More so, it could be money easy split from a tax return into purchasing savings bonds (now on the tax form!) or put into a savings account. Our surveys of EITC recipients increasingly find a desire to save a portion of their refund. In the last five years, “saving” a portion of a tax refund has gone from the 10^th most popular response to the fourth.

Jackson Hewitt’s woes give us a unique opportunity to pause and think about how to help working families secure all of their refund and grow it. Some 5% of EITC recipients use free tax clinics or programs such as the Volunteer Income Tax Assistance (VITA) program. And while all low-income families can’t be served by free tax operations, there are emerging options that are better alternatives to paid preparation for many families. A few include the Benefit Bank program that includes tax assistance with free public benefits screening, self-preparation with the help of a coach or volunteer, and using the IRS Free File option.

David Rothstein, researcher with Policy Matters Ohio, is a research fellow for the New America Foundation and a Steering Committee member of the National Community Tax Coalition. This article does not necessarily reflect the opinions of those organizations.