Undocumented Worker’s Loopholes to Avoid Federal Income Tax

State and Local Income Tax

On February 24, 2016, the Institute on Taxation and Economic Policy (ITEP) released a study that found that 50% of undocumented workers contributed billions of dollars each year in state and local taxes (ITEP, 2016). My first question is how do undocumented immigrants pay state and local taxes without a Social Security Number (SSN)?

One must apply for an Individual Taxpayer Identification Number (ITIN). According to the IRS, to be eligible for an Individual Taxpayer Identification Number (ITIN) states, “If you do not have a SSN and are not eligible to obtain a SSN, but you have a requirement to furnish a federal tax identification number or file a federal income tax return, you must apply for an ITIN (IRS.gov, 2016). This brings up my next question. Who needs an ITIN?

Individual Taxpayer Identification Number

IRS issues ITINs to foreign nationals and others who have federal tax reporting or filing requirements and do not qualify for SSNs. A non-resident alien individual not eligible for a SSN who is required to file a U.S. tax return only to claim a refund of tax under the provisions of a U.S. tax treaty needs an ITIN (IRS.gov, 2016). Makes sense. File for an ITIN and you can pay state and local, and even property taxes. What really struck me where the reports key findings.

The key findings for this report that undocumented immigrants contributed significantly to state and local taxes, collectively paying an estimated $11.64 billion a year (ITEP, 2016). However, when I went to verify that information the as listed second under the references section

The ITEP uses six methods to estimate the undocumented immigrants effective tax rates. Furthermore, as it turns out, “Undocumented immigrants are currently ineligible to receive the federal Earned Income Tax Credit (EITC) and state versions of the credit because they lack the legal authority to work in the U.S. (ITEP, 2016).” In short, because they are ineligible due to their “legal” status, these undocumented immigrants are unable to get tax breaks just like the rest of the United States’ legal tax payers. Furthermore, because they are ineligible to receive tax breaks they don’t pay federal income tax either. According the IRS Federal income tax is imposed on all citizens and residents of the United States, regardless of the State in which you live (US Tax Center, 2016).So, while the report does who a surplus of $11.64 billion a year in state and local taxes, it doesn’t’ point out the deficit from not pay federal taxes.

Progressive Tax System

To illustrate my point. Federal income tax tends to be more revenue for individual paid to the IRS. How much more? The Federal Income Tax uses a marginal tax bracket, while the state uses a progressive tax (except States like Pennsylvania that have flat taxes). For tax year 2013, there are 7 marginal income tax brackets for each filing status:

 

10 %, 15 %, 25 %, 28 %, 33 %, 35 %, and 39.6%[1]

 

Let’s say the 11 million undocumented immigrants fall in the bottom third of the tax brackets. Which means if you take the first three numbers on the left and average them out you get 16.66%. Now, we know that $11.64 billion was paid in state and local by 50% of those people.

Let’s say an average of $2 more per $1 dollar paid toward state and local taxes. So, if you multiply $11.64 billion by 2, then, the Federal Income Tax paid to the IRS by undocumented immigrants would be $23.28 billion combined with state and local taxes at a whopping $34.92 billion. That’s a pretty big surplus. However, because of their ineligibility to pay federal income tax, that put’s the actual total into a deficit. The IRS should be receiving $34.92 billion, instead the IRS is losing -$23.28 billion.

Death and Taxes

To illustrate the deficit even further, not only are the IRS not being paid the $23.28 billion dollars each year, only 50% of the undocumented immigrants are paying state and local taxes. So of the 11 million undocumented immigrants, 5 million are paying state and local taxes, and NONE (not one) of the 11 million are paying federal income tax. So, if we double (multiply by 50%) the $23.28 billion lost in federal income tax, that means that $46.56 billion in federal taxes are note being paid at all by these 11 million undocumented immigrants. So, when ITEP reports that 50% of undocumented immigrant are paying $11.64 in taxes, what they’re not telling is that they are really on pay 25% of what they should be paying. Everyone must pay taxes. Right? Benjamin Franklin in an 1879 letter wrote that “Our new Constitution is now established, and has an appearance that promises permanency; but in this world nothing can be said to be certain, except death and taxes.”

If 11 million undocumented immigrants pay $11.64 billion each year, but, only 50% of those 11 million are actually paying, if all paid it would be roughly double that number. Which, totals $23.28 billion. Plus, the lost revenue of not paying federal income tax which tends to be higher than most state taxes, would have to be higher than 50% of the payments made by undocumented immigrants. Not to mention, that the total of undocumented workers continues to increase each year. As of 2014, efforts to track these taxpayers down allowed the Social Security Administration to match 171 million tax forms to their rightful owners.

But there are still about 340 million unclaimed tax forms recorded in the file, compared to 270 million nearly a decade ago. A good portion of those forms were filed by employers on behalf of some of the most unlikely funders of Social Security: undocumented immigrants. In fact, illegal immigration is considered largely responsible for the mushrooming of the file, with undocumented workers paying billions in taxes for retirement benefits they will likely never receive (Campbell, 2016).

In summary, while the United States is receiving $11.64 billion in state and local taxes from undocumented immigrants, the U.S. in total is not receiving $58.2 billion in lost revenue.

References

Campbell, A. F. (2016). The Truth About Undocumented Immigrants and Taxes. The Atlantic. Retrieved from: https://www.theatlantic.com/business/archive/2016/09/undocumented-immigrants-and-taxes/499604/

IRS (2016). General ITIN Information. IRS.gov Retrieved from: https://www.irs.gov/individuals/general-itin-information

ITEP (2016). Undocumented Immagrants’ State& Local Tax Contributions. Institute on Taxation and Economic Policy. Retrieved from: http://itep.org/itep_reports/2016/02/undocumented-immigrants-state-local-tax-contributions-1.php#.Vs04cpwrKUk

US Tax Center (2016). State Income Tax vs. Federal Income Tax. US Tax Center. Retrieved from: https://www.irs.com/articles/state-income-tax-vs-federal-income-tax

[1] US Tax Center https://www.irs.com/articles/state-income-tax-vs-federal-income-tax 

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