Tax Fraud by Illegal Immigrants Costs Uncle Sam $4.2 Billion

Chart Showing The Amount of Tax Fraud for the Additional Child Tax Credit has Grown Tremendously

This story clearly falls into the category: “you just can’t make this stuff up.” First, who knew that illegal immigrants in America could even file a tax return, but they can and do. Even though they don’t have a Social Security number, they can get an Individual Taxpayer Identification Number (ITIN). The ITIN was created because everyone in the U.S., legal or not, is required to pay federal income taxes.

Of course, the whole idea that an illegal immigrant would go through the trouble of obtaining an ITIN just to pay Uncle Sam is ludicrous–and only exists in a bureaucrat’s dream. However, they would go through the trouble if they discovered that they could get Uncle Sam to pay them. And that’s exactly what has happened.

Some enterprising tax accountant, perhaps illegal, discovered that the “Additional Child Tax Credit” (ACTC) could be paid through an ITIN. The ACTC is the refundable portion of the child tax credit which is currently worth $1,000 per child. So, let’s say a taxpayer has a tax liability of $2,000, but has three children yielding a child tax credit worth $3,000 . . . that taxpayer would receive a refund of $1,000 since the child tax credit exceeds their tax liability by $1,000 ($3,000 minus $2,000).

The Treasury Inspector General for Tax Administration recently looked into this problem in a report titled “Individuals Who Are Not Authorized to Work in the United States Were Paid $4.2 Billion in Refundable Credits” (pdf) As you can see in the chart above, this ACTC fraud has been exploding. In 2010, over 3 million ITINs claimed $4.2 billion in ACTC payments.

But wait, there’s more . . . according to the report:

The payment of Federal funds through this tax benefit appears to provide an additional incentive for aliens to enter, reside, and work in the United States without authorization, which contradicts Federal law and policy to remove such incentives.

HHHmmm, so Uncle Sam’s left hand doesn’t know what his right hand is doing.

OK, let’s put this $4.2 billion into perspective. According to state data published by the IRS, in 2009, New Hampshire paid $4.5 billion in income taxes to Uncle Sam. Now imagine if a foreign power sailed to our shores and stole New Hampshire’s entire booty meant for Uncle Sam. In such a case, Uncle Sam would have declared war on that foreign power. Yet, such thievery is happening everyday via illegal immigrants and Uncle Sam does nothing.

Of course, I could have inserted a great many other states, even multiple states, other than New Hampshire such as: Alaska ($2.7 billion), Delaware ($2.7 billion), Washington, D.C. ($3.6 billion), Hawaii ($3.7 billion), Idaho ($2.9 billion), Maine ($3.1 billion), Montana ($2.3 billion), North Dakota ($2 billion), Rhode Island ($3.2 billion), South Dakota ($2.3 billion), Vermont ($1.7 billion), West Virginia ($3.7 billion), and Wyoming ($2.1 billion).

Additionally, in FY 2010, the ACTC cost $22.7 billion so $4.2 billion in fraud represents 19 percent of all ACTC payments . . . how many private businesses would still be in business if 19 percent of vendor payments were fraudulent?!

Also, being an economist, I found this passage particularly funny:

Another reason for the increase is that a significant number of individuals are filing multiple claims to obtain the ACTC for prior year tax returns (e.g., filing Tax Years 2007, 2008, and 2009 returns at the same time).  In Processing Year 2010, approximately 238,000 ITIN filers submitted more than 608,000 tax returns for multiple years at the same time and claimed just more than a billion dollars in ACTCs on those returns.  The ACTC claims for these individuals for the combined tax periods can be substantial . . . Moreover, in our analysis of returns filed in Processing Year 2010, some individuals had submitted duplicate tax returns for multiple years to multiple IRS processing centers and received ACTC refunds.

I guess incentives really do matter 🙂

Finally, I couldn’t get this video to embed, but if you have 6 minutes or so the video shows an investigative report titled “IRS Tax Loophole” that tells the story of a tax accountant who is blowing the whistle on this fraud.

Capital Gains Roller-Coaster and the Size of Government

New 2009 data from the IRS shows how foolish it is for government to tax capital gains income.  As shown in the chart below, capital gains income for 2009 is now back to 2002 levels ($224 billion).  Of course, thanks to the housing bubble, this is after a massive run-up in capital gains income to $819 billion in 2007.  This led to a whopping 73 percent drop in capital gains income from 2007 to 2009!

The capital gains roller-coaster also has a disproportionate effect on government budgets, especially Uncle Sam’s.  The IRS data shows that, in 2009, 87 percent of all capital gains income was claimed by those folks with income (as measured by Adjusted Gross Income) over $200,000.  That means these folks are paying at the highest marginal tax rates which can lead to rapid increases/decreases in government revenue.

This revenue volatility should also concern good/small government folks.  According to Dr. W. Mark Crain in his book Volatile States: Institutions, Policy, and the Performance of American State Economies:

 . . . uncertainty is the enemy of efficiency in public as well as private enterprise.  Budget volatility precludes efficient planning and adds significantly to the cost of government-provided services.  Put differently, a reduction in spending volatility would be equivalent to a funding increase.  The empirical evidence indicates that a 10 percent reduction in budget volatitlity generates efficiency gains comparable to a 3.5 percent increase in the level of funding . . .

The analsysis suggests that the reliability of tax revenues influences the size of government.  Greater instability in tax revenues contributes to spending instability that impedes the efficiency of long-run state government operations.  With less efficient planning, the level of government spending increases, which of course requires additional revenues. [emphasis added]

So in the long run, the volatility in the capital gains tax is helping to increase the size of government at all levels . . . with the exception of those states without an income/capital gains tax.  Um, like New Hampshire 🙂

There is, however, a silver lining in the capital gains volatility.  With capital gains income at such a low level, now is the time to ax the capital gains tax at the federal and state levels.  Not only is the cost of doing so minimized to government coffers, but it would also boost the incentive to invest in new capital which is exactly what the economy needs in this so-called “recovery.”

Chart Showing Capital Gains Income from 1997 to 2009

Landlords Get Caught in 1099 Dragnet

In my previous blog post, “Prepare for 900% Increase in 1099 Workload,” I estimated that the expanded requirements for filing a 1099 (on everything over $600 in value) could increase tax compliance as high as the estimated increase in revenue of $17 billion.  So the economy would suffer a net loss of $34 billion ($17 billion in new tax revenue and $17 billion in higher tax compliance costs).

Now Commerce Clearing House is reporting that the 1099 dragnet is widening and up next are landlords:

Congress in 2010 expanded the information return reporting requirements contained in Code Sec. 6041. Generally, Code Sec. 6041 requires payments of $600 or more to a single recipient in the course of a trade or business to be reported by the payor to the IRS and the payee, usually on Form 1099-MISC. There are exceptions to the general reporting requirements but these exceptions begin to disappear in 2011.

One of these disappearing exceptions to the reporting requirements involves landlords. The Small Business Jobs Act of 2010 (2010 Jobs Act) (P.L. 111-240) amended the definition of trade or business to include renting real property. Before 2011, most landlords were not subject to the reporting requirements because renting real property was not considered to be a trade or business. Under the new version of Code Sec. 6041, real property rental is now considered a trade or business but only for purposes of the reporting requirements.

Of course, as with many government regulations, there will also be unintended consequences.  In this case, the 1099 requirements could make landlords vulnerable to identity theft:

Since landlords have not, until now, been “engaged in a trade or business,” the reporting requirements create a problem. According to the instructions for Form 1099, sole proprietors and others, like landlords, who are not otherwise required to have an employer identification number (EIN) should use their Social Security number (SSN) for reporting purposes. Moreover, the instructions state that the filer’s name and TIN should be consisted with the name and TIN used on the filer’s other returns. This opens up the opportunity for identity theft.

So I wonder whose going to be scooped up next in the  1099 dragnet as more of these exceptions disappear?

Prepare for 900% Increase in 1099 Workload

I received an email from Commerce Clearing House (CCH), a major tax information firm for tax professionals, with this shocking headline–“Prepare for 900% in 1099 Workload.” What does this mean?  According to CCH:

Today most corporations are required to perform 1099 reporting for less than 10 percent of their supplier population, according to industry estimates. That will jump to an estimated 90 percent under new tax legislation that takes effect in 2012. Legislation could make corporations do nine times as much 1099 reporting.

Under the law, businesses will be required to report purchases of items like office equipment, food and bottled water, gasoline, lumber and plumbing supplies if payments to any vendor in the course of a year aggregate to at least $600. In many cases, companies will also have to report payments for things like travel, telephone and Internet service.

And why are they doing this to businesses? Shockingly, its all about the money.

The new reporting requirement, included in the Patient Protection and Affordable Care Act, aims to close an estimated $300 billion tax gap between what individuals and businesses owe compared to what they actually pay. Congress expects the 1099 measure to raise $17 billion in taxes and fees, offsetting part of the cost of health care reform.

OK, I’m having a really hard time justifying this draconian change in the tax laws to raise a measly $17 billion.  Folks in D.C. call such amounts “Fairy Dust.”  The article does not state which type of 1099 they are referring to, but my guess is that it is the 1099-MISC.  According to this document (pdf) from the IRS’s Statistics of Income Division, there were 85,524,982 1099-MISC forms filed in 2009.  Multiply that by nine times you get 769,724,838 forms.

Now, how much do you guess it costs to fill out the form, make copies, send one to the vendor and file one for your records?  I have no idea, but lets conservatively use a nice round number of $10.  That means the costs of compliance with this draconian measure will come to $7.7 billion–nearly 50 percent of the expected revenue increase!  Assume $20 and the tax compliance costs would nearly equal the expected revenue!

If you think that’s bad, let’s hope they don’t expand the requirements for filing a 1099-B (Proceeds for Broker and Barter Exchange Transactions) which had over 800 million filings in 2009.  Do the math on that one.

But wait there’s more.  It seems there is one loophole around this draconian measure:

So far, the IRS has said only that companies who pay bills with credit or debit cards will dodge the 1099 bullet, because the reporting burden will fall on the credit card companies, Roth says. But using credit cards in an attempt to avoid additional reporting burdens is not a good solution. Many vendors or suppliers may not want to allow it because of the extra cost to them of 2 to 3 percent per transaction, and some purchases will exceed the dollar limit for company credit cards.

Say what?!  So even avoiding the cost of filing the 1099 is going to cost businesses 2 to 3 percent per transactions and, if they hold a balance, interest.  Whoever thought of this idea needs to be taken behind the woodshed . . . better yet, make them file the first couple of million 1099s as community-service.

Isn’t already bad enough that American’s are already shouldering a $1.75 trillion burden complying with federal regulations.