Treasury and IRS move to restrict refundable tax credits based on immigration status

The Trump administration is proposing new tax rules that could change who is allowed to receive the refundable portion of several major federal tax credits — creating a new compliance issue for tax professionals serving immigrant and mixed-status households.

Why it matters: The proposal would connect eligibility for the refundable portion of four tax credits to a taxpayer’s immigration status under the Personal Responsibility and Work Opportunity Reconciliation Act of 1996, or PRWORA. That could make determining immigration eligibility a more explicit part of preparing certain returns.

What happened

On Aug. 19, the Treasury Department and IRS issued proposed regulations that would classify the refunded portion of certain refundable income tax credits as a “federal public benefit” for purposes of PRWORA.

The proposal covers four credits:

Child Tax Credit (CTC)
Earned Income Tax Credit (EITC)
American Opportunity Tax Credit (AOTC)
Adoption Tax Credit

Under the proposal, taxpayers generally would have to be a U.S. citizen, U.S. national or “qualified alien” when they file the return first claiming the affected credit in order to receive its refundable portion. Treasury says qualified aliens include lawful permanent residents, refugees, asylees and certain other groups covered by PRWORA.

The big distinction: credit vs. refund

This is one of the most important details for tax professionals.

The proposal does not necessarily eliminate the entire tax credit for someone who fails the immigration-status requirement.

Instead, Treasury is distinguishing between the portion of a credit that reduces federal income tax liability and the amount that generates a payment beyond that liability.

Treasury says only the refunded portion would be considered a federal public benefit. A taxpayer who isn’t eligible for that refundable portion could still potentially use an otherwise allowable portion of the credit to offset income tax liability.

Example: If an otherwise eligible credit reduces a taxpayer’s income tax liability from $1,500 to zero and would normally generate another $2,000 as a refundable amount, the immigration-status restriction contemplated by the proposal concerns that refundable $2,000. Actual results would depend on the taxpayer, the particular credit and the final regulations.

Another important detail: married couples

For taxpayers filing a joint return, only one spouse would need to be a U.S. citizen, U.S. national or qualified alien to satisfy this particular requirement for the refundable portion.

That provision could be especially significant for mixed-status households, where spouses have different immigration statuses.

What tax pros need to know

This could create a new due-diligence layer.

The proposed rules would require the taxpayer to declare under penalty of perjury on the return that they are eligible to receive the refundable portion of an affected credit.

For preparers, that means immigration status could become increasingly relevant when determining refundable-credit eligibility.

Tax offices serving immigrant communities may need to rethink their intake procedures, client questionnaires, documentation practices and staff training if the regulations become final.

And preparers should be careful not to assume that having an ITIN automatically answers the immigration-status question. The proposed standard is based on whether the taxpayer falls within the citizenship, nationality or qualified-alien categories specified under PRWORA—not simply which taxpayer identification number appears on the return.

Between the lines

The proposal represents something broader than another change to a tax form.

It further connects tax administration with federal immigration and public-benefit law.

Treasury says the rules follow a legal analysis from the Justice Department’s Office of Legal Counsel concluding that the refunded portions of the affected credits constitute federal public benefits under PRWORA.

That interpretation is what gives the proposal potentially significant consequences for tax professionals serving immigrant families.

Yes, but: These aren’t final rules yet

This is a proposed regulation, not a final regulation.

Treasury and the IRS are accepting public comments and requests for a public hearing. The proposed rules state that they would apply to tax years ending on or after the date the regulations are published as final regulations.

So preparers should not start denying credits based solely on this proposal.

Current law and existing IRS rules remain relevant until the regulatory process is completed and any final regulations become effective.

The bottom line for tax professionals

Don’t confuse immigration status, ITIN status and tax-credit eligibility. They are related in some situations, but they are not interchangeable concepts.

If these regulations are finalized substantially as proposed, tax professionals—particularly those serving Latino, immigrant and mixed-status households—may need to add immigration-status questions to their refundable-credit due diligence.

The critical question may no longer be simply:

“Does this taxpayer otherwise qualify for the credit?”

It may also become:

“Is this taxpayer legally eligible to receive the refundable portion of the credit under PRWORA?”

That distinction could become an important compliance issue heading into future filing seasons.

Go deeper: Treasury announcement · IRS guidance and summary of the proposal