Tax Benefits for Undocumented Immigrants and their U.S. Citizen Children

Overview

On the immigration front it has been mostly bad news since the Trump Administration assumed power. Many undocumented immigrants in the removal (deportation) who previously had grants of prosecutorial discretion from Immigration and Customs Enforcement (ICE) a year ago, now face themselves facing immediate deportation. Grants of prosecutorial discretion by ICE are almost non-existent. In short, the current environment is increasingly hostile. A seemingly unrelated item like tax reform could embolden the President and the Republican-controlled House and Senate to start “swinging for the fences” in regard to the rest of the President’s campaign promises due to the recent victory in Congress regarding tax reform.

While a decision regarding DACA hangs in the balance, the retention of the Child Tax Credit offers an opportunity that too few undocumented immigrants with U.S. citizen children have exploited. In the recent legislation, the Child Tax Credit was increased, creating a financial opportunity for undocumented immigrants and their U.S. citizen children, with an unexpected Christmas gift from the American Congress.

The problem for eligible U.S. children of undocumented parents is the requirement that there parents file a federal tax return to claim the child tax credit. One of the practical problems for many (read: most) undocumented immigrants with U.S. citizen children, is that they have never filed a tax return or have filed tax returns intermittently. Additionally, one of the requirements for the undocumented parent as the tax filer is to have a tax identification number – social security or ITIN.

Individual Tax Identification Number (ITIN)

An Individual Taxpayer Identification Number (ITIN) is a tax processing number issued by the Internal Revenue Service. The IRS issues ITINs to individuals who are required to have a U.S. taxpayer identification number but who do not have, and are not eligible to obtain, a Social Security number (SSN) from the Social Security Administration (SSA)

The IRS issues ITINs to help individuals comply with the U.S. tax laws, and to provide a means to efficiently process and account for tax returns and payments for those not eligible for Social Security numbers. They are issued regardless of immigration status, because both resident and nonresident aliens may have a U.S. filing or reporting requirement under the Internal Revenue Code. ITINs do not serve any purpose other than federal tax reporting.

An ITIN does not authorize work in the U.S. or provide eligibility for Social Security benefits

Do Undocumented Immigrants Need to File Tax Returns?

The problem of unfiled tax returns is a serious one irrespective of whether you have an immigration problem or not. Separate and apart from illegal immigrants, the IRS based on statistics in 2006 indicated that approximately 7 million taxpayers failed to file tax returns costing the taxpayers $28 billion. It is doubtful in my view that this number included the large number of undocumented immigrants.

In the worst-case scenario, the failure to file a tax return can be a criminal problem. IRC Sec 7203 treats the willful failure to file a tax return as a misdemeanor subject to a fine of $25,000 or imprisonment for a year or both including the costs of prosecution. As a practical matter, the IRS only prosecutes 300-400 failure to file cases per year. The indictment and successful prosecution rate is approximately 80 percent. The goal of prosecution is to encourage taxpayer compliance using high profile taxpayers, i.e. cases like Wesley Snipes.

The civil penalties for the failure to file a federal tax return are equally onerous. A 5% penalty (computed on the amount of tax required to be shown on the return) is imposed for each month the return is past due, up to a maximum of 25%. If the failure to file is the result of fraud, the 5% civil penalty is increased to 15% per month of the tax required to be shown on the return, up to a maximum of 75%.

In addition, a penalty of .5% (¹/2 of one percent) per month of the amount of tax required to be shown on the return, up to 25% of such tax, is imposed for late payment of the tax due. In addition to the penalties for a failure to file and late payment of the tax considerations, a taxpayer may also forfeit refunds due from delinquent returns since any return filed more than three years after its due date cannot receive a tax refund

Overview of the Child Tax Credit

Under Tax Reform, the Child Tax Credit may be worth as much as $2,000 per qualifying child depending upon your income This credit is for people who have a qualifying child. A qualifying child for purposes of the child tax credit is a son, daughter, stepchild, foster child, brother, sister, stepbrother, stepsister, half-brother, half-sister, or a descendant of any of them (for example, your grandchild, niece, or nephew). The child must be under age 17 at the end of 2017. Additionally, the child cannot have provided over half of his financial support in 2017. The parent should have claimed the child as a dependent on the federal tax return. The child must be a U.S. citizen or resident alien (green card holder).

A child is considered to have lived with the taxpayer for more than half of 2017 if the child was born or died in 2017 and the taxpayer’s home was this child's home for more than half the time he or she was alive. Temporary absences by the taxpayer or the child for special circumstances, such as school, vacation, business, medical care, military service, or detention in a juvenile facility, count as time the child lived with you. There are also exceptions for kidnapped children and children of divorced or separated parents.

In prior years, the Child Tax Credit was nonrefundable meaning that if the available tax credit exceeded the taxpayer’s tax liability, the tax bill was simply reduced to zero. So even if the taxpayer was able to claim the entire $1,000 per child (the maximum available credit for the 2017 tax year), if the taxpayer didn't have any tax liability, the taxpayer couldn't benefit from the credit. The credit would not carry forward to any future years, or back to any past years: it simply disappeared.

Under Tax Reform, part of the Child Tax Credit remains non-refundable but the "old" Additional Child Tax Credit, which was refundable, has essentially been merged into the new credit. The new Child Tax Credit is just one credit worth up to $2,000 per child and includes a refundable piece of up to $1,400 per child. To be clear, the $1,400 refundable piece is included as part of the $2,000 Child Tax Credit and is not an additional credit.

A refundable credit means that the taxpayer can take advantage of the credit even if you do not owe any tax. Unlike a non-refundable credit, if the taxpayer does not have any tax liability, the "excess" credit is not lost but is instead refunded to the taxpayer. To claim the refundable portion, the taxpayer must have earned income (generally, wages, salary, tips, and net earnings from self-employment). For purposes of the new Child Tax Credit, the refundable portion is equal to 15% of your earned income which exceeds $2,500 up to the maximum credit.

Example 1

Joao and Maria have earned income is $10,000 and let's assume that you are entitled to the entire $2,000 credit. However, at that income level, you likely don't owe any tax. With the refundable piece of the credit, you can pocket up to $1,125 since $10,000 (your earned income) less $2,500 x 15% = $1,125.

Under Tax Reform, the child credit includes a $500 non-refundable credit for qualifying dependents other than qualifying children. This additional credit referred to as a "family credit" and allows you to claim a credit for other dependents in your household that don't meet the definition of qualifying child. For purposes of the additional non-refundable "family" credit, the definition of dependent still generally applies but there is no requirement to provide an SSN. However, the dependents would need an ITIN.

The taxpayer who is claiming a child tax credit or additional child tax credit for a child identified on your tax return with an ITIN, you must complete Part I of Schedule 8812 (Form 1040A or 1040). The credit is not available filing Form 1040EZ. An ITIN is for tax use only and may expire under certain conditions. See the Instructions for Form W-7 for details. Although a child may be your dependent, you may claim a child tax credit or additional child tax credit only for a dependent who is a citizen, national, or resident of the United States. To be treated as a resident of the United States, a child generally will need to meet the requirements of the substantial presence test.

Summary

It is ironic in the Trump administration with its tough posture on immigration, that the much-heralded tax reform might benefit Americans and the undocumented as well. It is a very common fact pattern that many of the undocumented have U.S. citizen children and undocumented parents living with them. The changes in the Child Tax Credit provide the undocumented with an opportunity to be tax compliant and benefit with the refundable portion of the tax credit. At the least, President might send the Undocumented home with money in their pocket!