You asked so many questions, I'll try to get them all:
3 . What Islam says about those Muslims who participate in non-Muslims religious activities?
The Prophet (PBUH) said:
حَدَّثَنَا مُوسَى بْنُ إِسْمَاعِيلَ، حَدَّثَنَا حَمَّادٌ، عَنْ حُمَيْدٍ، عَنْ أَنَسٍ، قَالَ قَدِمَ رَسُولُ اللَّهِ صلى الله عليه وسلم الْمَدِينَةَ وَلَهُمْ يَوْمَانِ يَلْعَبُونَ فِيهِمَا فَقَالَ " مَا هَذَانِ الْيَوْمَانِ " . قَالُوا كُنَّا نَلْعَبُ فِيهِمَا فِي الْجَاهِلِيَّةِ . فَقَالَ رَسُولُ اللَّهِ صلى الله عليه وسلم " إِنَّ اللَّهَ قَدْ أَبْدَلَكُمْ بِهِمَا خَيْرًا مِنْهُمَا يَوْمَ الأَضْحَى وَيَوْمَ الْفِطْرِ " .
When the Messenger of Allah (ﷺ) came to Medina, the people had two days on which they engaged in games. He asked: What are these two days (what is the significance)? They said: We used to engage ourselves on them in the pre-Islamic period. The Messenger of Allah (ﷺ) said: Allah has substituted for them something better than them, the day of sacrifice and the day of the breaking of the fast.
Many scholars took this hadith as a forbiddance to celebrate non Muslim holidays. However, note that the Prophet did not forbid but simply said they were replaced.
Celebrating Christmas (Mowalid Alnabi Issa) is on the same level of Celebrating the Mowalid Alnabi Mohamed, many classify it as Bida that is forbidden as it was never done by the prophet, companions or their followers.
Celebrating atheist holidays, are our of the question, this includes any Muslim/Jewish/Christian holidays that have shirk in them.
Since you didn't ask about non-religious holidays, I won't mention it but that question itself has been answered (disputed).
1.Should their kids not participate in those activities and tell the teachers that they are not interested or can they do some activities like wearing costumes for Halloween ,trick or treat, decorating Christmas tree?
I wouldn't recommend they do, imo, since they are small and easily impressionable. You can spurge on them once Islamic holidays come and explain to them why they shouldn't be celebrating holidays they don't believe in.
2.Some Masajid arrange special events in same day for Muslim kids like magic shows and others where they distribute candies so kids don't feel to go for trick or treat activities so is it allowed to do such in premises?
I am guessing that the Imam or leader of such Masjid made such decision, it is not for us to judge him until you speak to him and explain your point of view and his and why they are doing so. Personally, Magic shows I wouldn't do in the Masjid as some scholars say that trickery is part of Shirk.
However, if you are in America most of the times that you can see your family is during such holidays, specially if your family is not Muslim, in such cases it doesn't hurt to join them in such celebration in the basis of
Here are some Fatwa in regards to the forbiddance of celebration and their reasons, most of them are extreme in such that even holiday greetings are forbidden:
You have both sides, it is up to you to choose.