First passed by Congress in 1997, child tax credits were intended to benefit children and to help keep them from falling into poverty. The eligibility to claim the credit is tied to the child and not to the parent. The child being claimed must be under the age of 17, a legal dependent of the tax filer, must have lived with the filer for more than half of the year, and must be a U.S. citizen, a U.S. national, or a U.S. resident alien. The tax code explicitly requires documentation of the child’s citizenship or residency, but not the claimant’s.

Some taxpayers are improperly using an Individual Taxpayer Identification Number, or ITIN (intended for people who are not eligible for a Social Security number). They are committing fraud by claiming the child tax credit for children who either do not exist or not living with them in the United States. The penalty, if you are caught and prosecuted – in addition to being charged with perjury – you will likely face fines for your mistake. The fines range from relatively small amounts to $225,000. You may also be responsible for the court’s prosecution costs and face up to three years in prison.

While a small number of taxpayers may attempt this fraud, there are safeguards written into the Tax Code to catch the misuse. For example, if more than one filer attempts to claim the same child, an automatic audit is triggered by the Internal Revenue Service. There is little evidence that such double claiming occurs frequently and, in any case, it is quickly resolved via an enforcement audit. Tax returns are also flagged for audits when filers attempt to claim a large number of dependents. A low-income filer who files such a claim would likely be reviewed before a refund is sent.

The average household income for filers without a Social Security number and claiming the additional child tax credit refund in 2010, was about $21,240, less than half of the 2010 US median income. According to the U.S. Treasury Department, the average child tax credit refund was about $1,800, which would require at least two dependent children. Even for lower-income families and rural communities, the annual cost of raising a child is around $10,000 per year.

There is talk of restricting eligibility to the Child Tax Credit, but such legislation would heavily and disproportionately impact people of color. Latino children are much more likely to live in poverty than any other racial or ethnic group, and more than half of the 6.1 million Latino children in poverty are U.S.-born children of immigrants.

North Carolina is part of what federal investigators call a nationwide tax fraud scheme among suspected illegal immigrants. It’s a system auditors believe invites fraud and abuse topping more than $4 billion a year. Federal reports dating back more than a decade warned the Internal Revenue Service about the use of invalid ITINs. Investigators uncovered more than 1,000 tax returns linked to eight addresses in North Carolina last May, with refunds worth more than $5 million.

These tax fraud schemes are a problem across the U.S. and include refunds given for children, many of whom don’t live in the U.S. or don’t even exist, according to the Treasury Inspector General for Tax Administration.

The fraud was tracked to an apartment complex in Charlotte, where two women were arrested and charged with coordinating hundreds of fraudulent tax returns which all wound up at a small number of mailboxes.

The U.S. Postal Service contacted the IRS after they noticed a flood of “suspicious mailings from the U.S. Treasury Department appearing to contain Treasury checks” hitting the same mailboxes. Ultimately they tied at least 17 tax returns, totaling more than $62,000 in refunds, to a Charlotte apartment. At another apartment nearby, investigators turned up 153 returns valued at $713,000 in refunds. Searching still another address in the same apartment complex turned up 236 returns worth $1.1 million in refunds.

Investigators say the clustered addresses and a bank of mailboxes made for easy access to those refunds. An apartment complex manager told investigators he had seen the same woman taking mail from all three apartment mailboxes. At another apartment nearby, $1.9 million in fraudulent returns were discovered.

“These applications for ITINs coming from the same address, thousands of applications … or thousands of returns, coming from the same address – that screams fraud,” said former federal prosecutor Clay Wheeler, who specializes in tax fraud cases and currently works for Kilpatrick, Townsend and Stockton law firm in Raleigh. “It looks to me like the ITIN system has a lot of holes in it that need to be fixed … You can’t help but be angry about that kind of fraud.”

In the 2012 IRS audit of ITINs’ it was determined that “Management has not established adequate internal controls to detect and prevent the assignment of an ITIN to individuals submitting questionable applications.” The key problem being that the IRS accepted copies of documents used to substantiate the applicant’s identity and foreign status, which prevented adequate verification. The assignment of an ITIN based on questionable documentation enables individuals to then use this ITIN to file tax returns to commit tax refund fraud.

The audit further determined that the existing ITIN review process:

  1. Discouraged tax examiners from identifying questionable applications.
  2. Eliminated successful processes used to identify fraudulent ITIN application schemes.
  3. Established processes inadequate to verify each applicant’s identity and foreign status.
  4. Was interested only in the volume of applications that could be processed, not legitimacy.
  5. Allowed billions of dollars in erroneous tax refunds to go to non-qualifying individuals.
  6. Used employees who were unable to tell a real document from a fake one.
  7. The IRS accepts copies of identifying documents.
  8. Copied documents have led to the creation of identities in the IRS’s Real-Time System, making it difficult to determine if the specific individual is or ever was a real person.

To obtain an ITIN, an alien individual, their spouse, or qualifying dependent(s) must complete Form W-7 and send it to the IRS Submission Processing Center in Austin, Texas, or provide it to an IRS assistor at a Taxpayer Assistance Center. The applicant may also submit the Form W-7 to an IRS authorized Acceptance Agent. The role of an Acceptance Agent is to assist applicants in completing the ITIN application, to review and certify that the applicant’s supporting documentation is accurate, and to forward the completed form and certification to the Austin Submission Processing Center. Unlike Acceptance Agents, those individuals who are Certifying Acceptance Agents are authorized to certify whether the required documentation to support the identity and foreign status of an individual applying for an ITIN is adequate.

The IRS proposes a sensible way to limit the fraud would be to require tax preparers to obtain proof of residency of the child prior to electronically filing tax returns. They feel the for-profit tax preparation industry should bear the burden of documenting residency of the children because the preparers, in many cases, are to blame for the false claims. Requiring preparers to obtain the documentation would not impose any new burden on the IRS and would assist the government in ensuring that tax preparers are diligent.

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