The U.S. Presidential Elections have shifted into overdrive with both the Republican and Democratic holding their conventions over the next two weeks to select Donald Trump and Hillary Clinton as their party’s candidates respectively. Viewed in tandem with Britain’s departure from the European Union and recent acts of terrorism in France and Belgium, the political climate with respect to immigration is decisively negative. It seems increasingly likely that immigration reform following the election will introduce tougher measures regardless of who wins the election. Unfortunately, if Donald Trump wins the election, and you’re an undocumented immigrant, it may be time to start packing your luggage!
One of the items that has been decidedly overlooked in the discussion of immigration reform and the 12 million immigrants that are currently out-of-status, is the impact of taxation on current immigration status and future immigration benefits. This article is designed to discuss the financial and immigration consequences and ramifications of years of unfiled federal and state level tax returns.
Unfortunately, the consequences in my view are severe enough to break the hope and promise of the American Dream. Aside from identifying the problem, the article outlines several strategies in order to become compliant in anticipation of tax reform.
Undocumented Immigrants and Taxes
The Pew Hispanic Center study as of March 2005, estimated that the undocumented U.S. population had reached 11 million or more, including more than 6.5 million undocumented Mexicans, which is around 60% of all unauthorized immigrants. This number is the same number that is still thrown around currently. The Department of Homeland Security in January 2012 suggested that the number of illegal immigrants was between 11 or 12 million. Donald Trump and the bombastic Ann Coulter suggest that the number is at least 30 million based upon the level money being sent back overseas.
The Institute of Taxation and Economic Policy reported that the tax contributions of undocumented immigrants is significant – $11.64 billion per year. Their data suggests that illegal immigrants pay an average of 8 percent of their income in state and local in taxes. Of this total, $1.1 billion accounts for the payment of personal income taxes. The majority of the taxes paid are for sales taxes and property taxes. The same research suggests that the compliance rate for personal income tax returns is 50-75 percent. Wishful thinking in my view!
In my view and experience, very few undocumented or out of status persons file a federal or state tax return. Any personal income taxes that paid at the federal or state are the result of employer withholding. Undocumented workers who are statutory W-2 employees have usually become so using false social security taxes. The IRS has previously indicated that they troubled by the use of false social security number but instead focused on the need to collect the tax. Additionally, many of the undocumented are paid off of the company’s books.
Some of the undocumented persons who have filed tax returns applied for and received individual tax identification numbers (ITIN). As a practical matter, many employers who have contracted undocumented workers have sought to treat these workers as independent contractors whether they are or not in order to avoid the employer-employee Form I-9 requirements. These contractors would generally have their income reported to the IRS on Form 1099.
The Problem with Unfiled 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 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%. This equates to a 60 percent annualized rate. 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. If a taxpayer fails to file a return, the effective annual rates is over 75 percent when both the interest and the late filing and late payment penalties are considered.
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 3 years after its due date cannot receive a tax refund
In the event a taxpayer has not filed a return, IRC Sec 6020(b) authorizes the IRS to prepare a return on the taxpayer’s behalf. The IRS through its Substitute for Return (SFR) Program prepares tax returns for non-filers by inputting information returns into its computers and generating a substitute for return (SFR) based upon information received from third parties. The taxpayer is not given credit for expenses, deductions, or other tax benefits. Most tax investigations are initiated because of computer matches based on information that it receives such as W-2 and 1099s.
From a legal standpoint, the non-filer is required to file all delinquent tax returns, whether that be one year or ten years. Despite this, some practitioners recommend filing only the returns the IRS requests, others recommend filing only the last three years (particularly when the non-filer is making a voluntary disclosure), while others recommend filing the last six years of returns.
Attorneys focus on the six-year federal statute of limitations period for prosecuting persons for criminal failure to file a tax return. This six-year limitations period has been taken into consideration in the IRS policy statement on enforcing the filing of delinquent tax returns. In Policy Statement 5-133, the IRS generally requires the filing of returns for the last six years, with prior managerial approval required to pick up either more or less than six years of returns.
In situations involving unfiled tax returns, married taxpayers, either joint or separate returns can be filed. In many cases, it is preferable to file separate tax returns rather than a joint return. Married taxpayers who file a joint return are jointly and severally liable under IRC Sec 6013(d)(3) for the resulting tax. In contrast, married taxpayers who file separate returns are liable only for their separate tax liability.
Adding salt to the tax wound, States may also impose civil penalties for the failure to file a state tax return and the late payment of the tax. Massachusetts imposes a civil penalty under Mass General Laws 62C§ 33(a) and 33(b) for the failure to file a return and the late payment of the tax. The penalty for each is one percent per month of the unpaid tax up to a maximum of 25 percent.
Joao came to the United States at the end of 2008.He has not filed a federal tax return since he has been in the United States. The amount of federal tax liability in each tax year is $1,000 from 2009-2015. The chart below outlines the year-by-year penalties and interest. The total amount of back taxes with penalties and interest is $10,750. The number could potentially be double this amount if the state of residence also has a state income tax, failure to file and late payment penalties.
|Year||Tax Due||Failure to File Penalty||Failure to Pay Penalty||Interest||Total|
The Immigration Consequences of Unfiled Tax Returns
The Immigration and Nationality Act (INA) contains two major sections that impose immigration law sanctions for crimes. INA §212(a) lists the grounds of immigration inadmissibility for crimes. INA §237(a) lists the classes of non-American citizens deportable for crimes. INA §212(a)(2)(A)(i) states that an immigrant that is convicted of a crime of moral turpitude is inadmissible. §237(a)(2)(i) states that an immigrant that is convicted of a crime of moral turpitude within five years of admission that has a sentence of a year or longer is deportable.
A crime of moral turpitude is a vague term, and is not defined in the immigration statutes. The detailed definition tax has been left to the courts on a case-by-case basis. Certain tax crimes such as such as aiding and assisting in the preparation of a false tax return or willfully making or subscribing to a false statement on a tax return (IRC Sec 7206) are felonies as well as crimes of moral turpitude. The failure to file under IRC 7203 is a misdemeanor subject to an imprisonment of a year as well as being a crime of moral turpitude.
For resident aliens with a Green Card, the failure to file as a crime of moral turpitude implicates “good moral character” for purposes of naturalization. In order to be eligible for naturalization, the applicant must establish a period of good moral character (usually five years). “Good moral character” specifically references inadmissibility due to crimes of moral turpitude. A person who is unable to establish “good moral character” will be denied naturalization. Furthermore, an individual who admits criminal activity, but has not been convicted on a charge relating to that activity will be treated the same under the law as an individual who has a final conviction.
The undocumented immigrant carries the tax compliance risk at both the federal and state level. Inadmissibility due to tax non-compliance is unlike other matters of inadmissibility that can be legally cured with a waiver. The only method to resolve the issue is to file past due returns and either pay the tax completely or make arrangements for payment of the tax. As a practical matter, it is unimaginable to believe that any proposed immigration reform will offer a pathway to residency without tax compliance.
Where Do We Go From Here?
A primary objective in representing a non-filer is the avoidance of criminal and civil penalties. Delinquent returns should be filed right away regardless of whether or not the taxpayer has the money to pay the IRS or state revenue agency. The delinquent returns should be accurate and defensible. Conservatism dictates that all questionable items be resolved in favor of the IRS.
Undocumented immigrants should request an ITIN from an ITIN certifying agent in the event that they don’t have a social security number. They should file at least the last six years of tax returns according to IRS Policy Statement 5-133. However, the statute of limitation for unfiled tax returns is unlimited. As the example above demonstrates, it does not take much of a tax liability to create a large financial problem once interest and penalties over a period of years is considered.
The problem with how to pay the back tax is a different problem. A number of potential solutions exist for taxpayers – installment agreements, abatements of penalties, and offer in compromise. Each situation is different based upon the taxpayer’s individual circumstances.
Most immigrants came to the United States for political and economic reasons – the American Dream. The problem of unfiled tax returns is a chronic and systemic problem facing virtually all of the undocumented immigrants and visa overstays in the United States. Up until now, the only federal agency to fear has been the Department of Homeland Security. However, most Americans would say that IRS is a more formidable foe.
The problem of unfiled tax returns as a crime of moral turpitude is a “deal killer” for any resident alien seeking to naturalize or undocumented immigrant seeking a pathway through any future immigration reform. The problem actually has two sides – compliance at the federal and state level. Some state departments of revenue such as New York are actually more aggressive than the IRS.
Unlike other legal waivers for inadmissibility, this problem has one solution – full tax compliance. Full tax compliance can only be met through filing unfiled returns for at least the last six years and an arrangement to pay all back taxes, penalties and interest.
The first step in solving any problem is realizing that you have a problem.. It is bad enough to have obstacles preventing legal immigration status, but the realization that you owe the federal or state government thousands of dollars in back taxes, penalties and interest, makes the tax problem more insidious than other criminal problems. Although the IRS is unlikely to prosecute an undocumented immigrant for tax crimes, it can. Regardless of any IRS to prosecute, it still has immigration consequences and the taxpayer still owes the back taxes.
In the current political environment, and its focus on immigration reform, a betting man should assume that short term future will result in dramatic changes. Any pathway towards residency or legal status will certainly require full tax compliance in order to resolve this ground of immigration inadmissibility. It is also conceivable that the federal or a state government, could levy an undocumented immigrant’s property even if the immigrant was in the deportation process. As a result, any immigrant taxpayer that is not currently compliant with federal or state tax requirements should do so without any delay.
Gerald Nowotny – Osborne & Osborne, PA
266 Lovely Street
Avon, CT 06001