I. Introduction
As I watched the Mandalorian, Season 1, there were clearly some tax issues raised, which I’m sure you all thought while you were watching as well. Something along the lines of “why is Disney so focused on ensuring tax literacy through the guise of this excellent TV show?” Well, this post deals with that so, be forewarned, SPOILERS AHEAD, as I will discuss the conclusion of the season and it’s interaction with tax law. Let’s get started shall we.
II. Background
At the conclusion of season one, the Child is placed in the hands of its[1] Mandalorian protector, much the same way Mando was protected by a Mandalorian guardian as a child/youngling. Once a youngling is taken under the care of a Mandalorian, the Mandalorian creed demands the Mandalorian care for the youngling and raise them as their own. This is the way. Mando therefore has an obligation to raise the Child in the Mandalorian religion and belief, meaning *fingers crossed* we are going to get the child in traditional Mandalorian armor in the coming season (I for one can’t wait to see a Mandalorian helmet with ears!).[2] What this really means is that Mando has potentially adopted the Child, or even if there is no actual adoption, the Child has been placed in the care of Mando, and will be considered a dependent for tax purposes.
Now that Mando has a new dependent in the household, he has some paperwork to do. The end of a year (or TV season) and life changing events are always a good time to review your tax withholdings.
III. Tax Withholding Generally
Individual federal income taxes are a “pay as you go” tax meaning that individuals are required to pay in a minimum amount on their account during the year, either through estimated quarterly payments, or as applicable to most individuals, through tax withholding on wages paid by employers. Generally speaking, taxes are withheld from employee paychecks by the employer and remitted to the federal government on the employee’s behalf.[3] For simplification, let us make an assumption that the guild and its members operate in an employer/employee style relationship.[4]
IV. Wage Withholding As the Tax Withholding Mechanism
The amount of an employee’s tax withholding is determined by the elections the employee makes on Form W-4. Form W-4 allows employees to determine the appropriate amount of withholding from their employer. The Internal Revenue Service (IRS) recommends that employees review their withholding determinations annually, but especially when the employee experiences “life changes” such as marriage, divorce, birth or adoption of a child, home purchase, retirement, etc.[5]
a. Wage Withholding by Employer
Employers are required to withhold income tax from wages, salaries, or other compensation paid to employees at rates designed to equal the tax liability that is anticipated will be imposed on these payments.[6] At periodic intervals the employer must report and pay over to the IRS the amounts withheld from its employees.[7] This withholding helps to ensure that tax compliance is automatic and funded, helping to eliminate the compliance gap associated with tax compliance. Considering the number of individual returns filed, this withholding funds the majority of the tax collection made by the US Treasury Department.
While the Employer will remit the tax withheld from the employee’s wages, the employer is directed how to withhold on behalf of the employee based on Form W-4. Each employee is required to furnish their employer Form W-4 which communicates the withholding status of each employee.[8] On the basis of the information provided on Form W-4, the employer withholds the appropriate amount of tax, and files a quarterly return of employment taxes withheld on Form 941.[9] The employer also provides the employee with a Form W-2 reflecting the total wages paid and amount of tax withheld on or before January 31 after the close of the calendar year.[10] The amounts of tax withheld are remitted to the IRS quarterly or deposited with a depository bank authorized by the IRS pursuant to a specified depository procedure based on the total amount of taxes withheld.[11]
This is the Guild’s responsibility; however, they operate under the direction of Mando as to how much to withhold per pay period. And Mando’s life has changed, as he is now the guardian of the Child, so his withholding exemptions should be adjusted accordingly.
b. Wage Withholding Exemptions and Employee Adjustment of Form W-4
Assuming that Mando takes the IRS advice and reviews his withholdings on an annual basis, he will need to update his withholding calculations in order to account for the new dependent in his life.
i. Determination of Whether the Child is a Dependent
As depicted within the Mandalorian, the Child does not appear to have a family (that we have seen), it has been kidnapped, not once, but twice, with the second kidnapping resulting in the Child’s connection with Mando. Therefore, we will assume that there is no other family for the Child, and that Mando is currently its appropriate (and dare we even say lawful) guardian.
Generally, a dependent is an individual who is either a qualifying child or a qualifying relative of the taxpayer.[12] The taxpayer has the burden of proving that a person claimed as a dependent exists and qualifies as a dependent.[13] Here, Mando needs to demonstrate that the Child is a “qualifying child” for IRS purposes.
ii. Qualifying Child
A qualifying child, with respect to any taxpayer for any tax year, is an individual who satisfies five conditions.[14] First, the individual must bear a qualifying child relationship to the taxpayer.[15] Second, the individual must have the same principal place of abode as does the taxpayer for more than one-half of the tax year.[16] Third, the individual must meet the age requirements.[17] Fourth, the individual must not have provided more than one-half of his or her own support for the calendar year in which the tax year of the taxpayer begins.[18] Fifth, for tax years beginning after 2008, the individual must not file a joint return, other than a joint return filed solely as a claim for refund of estimated or withheld taxes, with the individual’s spouse for the tax year beginning in the calendar year in which the tax year of the taxpayer begins.[19] In Mando’s case, the only items that really need examination are the first (qualifying relationship); second (principle place of abode); and third (age requirements).
1. Qualifying Relationship
A qualifying child relationship exists if the individual is any of the following:[20] (i) a child of the taxpayer;[21] (ii) a descendant of a child of the taxpayer;[22] (iii) a brother, sister, stepbrother, or stepsister of the taxpayer;[23] or (iv) a descendant of a brother, sister, stepbrother, or stepsister of the taxpayer.[24]
These appear to be difficult roles for Mando to slot into with regard to the Child. Mando seems to look more like a “foster parent” than an adoptive parent at this stage in the series. Generally speaking, “foster child” describes a relationship in which a child is not living with either of the child’s natural parents and has not yet been legally adopted.[25]
Foster children are considered part of a household, and therefore eligible for determination of being a qualified child if the foster child is “a member of the household for more than one-half of the period after the individual’s birth, adoption, or placement for adoption or in foster care or before the individual’s death.”[26] Being a “foster child” means that the Child is considered a “child of the taxpayer.”[27] This effectively demonstrates that foster children can be considered dependents if they are members of the household. As such, we can treat the Child as a “qualifying relative” to Mando.
2. Principle Place of Abode
I mention this only because I think that Mando sleeps in his ship. That seems uncomfortable, but that seems to be the case. So, yeah, looks like they share the same principle place of abode. But, let’s explore.
To meet the residency requirement, the qualifying child must have the same principal place of abode as the taxpayer for more than one-half of the tax year. A person’s “principal place of abode” is the primary or main home or dwelling where the person resides.[28] So, a flying ship, so long as they are both residing in it should qualify.
If, during a taxpayer’s tax year, the taxpayer adopts a child, a child is lawfully placed with a taxpayer for legal adoption by that taxpayer, or an eligible foster child is placed with a taxpayer, the residency requirement for a qualifying child is treated as met if the taxpayer and the child have the same principal place of abode for more than one-half of the portion of the tax year as required for a qualifying child following the placement of the child with the taxpayer.[29] So, as long as Mando and the Child are together, if they spend more than ½ of their nights together in that cramped ship, again, they should meet the residency requirements.
Interestingly, a qualified kidnapped child is treated as having the same principal place of abode as the taxpayer (yes, this exists in the internal revenue code).[30] A qualified kidnapped child is a child of the taxpayer who satisfies two conditions.[31] First, the child must be presumed by law enforcement authorities to have been kidnapped by someone who is not a member of the child’s family or the taxpayer’s family.[32] Second, the child must have had, for the tax year in which the kidnapping occurred, the same principal place of abode as did the taxpayer for more than one-half of the portion of the year before the date of the kidnapping.[33] This treatment ends as of the taxpayer’s first tax year beginning after the earlier of the calendar year in which there is a determination that the child is dead or the calendar year in which the child would have attained age 18.[34]
Here, while it is safe to assume that the Child was kidnapped at some point (and possibly even kidnapped by Mando), the relationship has shifted, and Mando is more in line with a foster parent, so that analysis should be applied. However, during the period when the Child was first kidnapped, its biological parents could have relied on the kidnapped child statute to maintain their dependent tax deduction. What a wild universe.
3. Age Requirements
This one is tricky. Technically, the Child does not meet the age requirement as it is 50 years old. However, if you take a human average life and the average life of the Child’s species, then there may be an argument that the Child’s age (50) is not a hindrance to making the Child a dependent.[35]
The age requirement is met if an individual satisfies any one of three tests, so long as the taxpayer claiming the individual as a qualifying child is older than the child.[36] The first test is met if the individual has not attained the age of 19 as of the close of the calendar year;[37] the second test is met if the individual is a student who has not attained the age of 24 by the end of the calendar year;[38] and the third test is met if the individual is permanently and totally disabled[39] at any time during the calendar year.[40] The IRS has ruled that, for these purposes, a child attains a particular age on the child’s birthday.[41] In addition to satisfying one of the three tests above, a taxpayer claiming the individual as a qualifying child must also be older than the child.[42]
Here, the Child has both obtained an age older than the highest available student age (24) and at the ripe young age of 50, is potentially older than Mando (although that is not free from doubt). Utilizing the rationale for converting the Child’s age into human years, we see that the Child is effectively only 5, and thus we are able to drive the Child’s age within the qualifying ages, and drive Mando’s age in excess of the Child’s, meaning that we can make the case that the Child and Mando satisfy the age requirements of IRC §152.
c. Impact of Determining the Child is a Dependent
Introduction of a new dependent into one’s life, such as the Child for Mando, is a major life event, as well as a major tax event. Mando could previously claim an additional allowance for a dependent and may still qualify for the Child Tax Credit, Child Care Tax Credit and other tax breaks. For tax years beginning before January 1, 2018 an individual taxpayer was allowed one personal exemption themselves and one for each dependent. For tax years prior to 2018, the exemption was $4,050 per dependent. After passage of the tax cuts and jobs act (TCJA) personal exemptions were eliminated and the standard deduction was increased. This means that the deduction for personal exemptions such as for a taxpayer, a taxpayer’s spouse, and a taxpayer’s dependents is $0 for tax years 2018 through 2025.[43] While dependent deductions are no longer available, the Child Tax Credit is still available, and the value has been increased from $1,000 per child to $2,000 per child. If Mando can’t qualify the Child for the Child Tax Credit, he could possibly still take a benefit from the credit for other dependents, which is significantly less than the child tax credit, but hey, it’s not nothing ($500 per qualifying dependent).
Additionally, for Mando, if he ultimately adopts the Child, he is eligible for the adoption tax credit. However, this post is not about the tax benefits of having kids, it’s about how to update your W-4 if you are a Mandalorian who happens to foster or adopt a young force powerful creature. The addition of a dependent in your life may still allow Mando to reduce his withholding to account for the added tax benefits, providing him more in his pocket from his paycheck. While the elimination of the personal exemption will reduce the benefit Mando sees in his after tax paycheck, Mando should still update his tax forms after adding a dependent to his household.
d. How to Update Form W-4
As shown above, the Guild, as Mando’s employer, has an obligation to withhold and remit taxes on Mando’s behalf, collected from his salary. The amount of the withholding is based on the Form W-4 Mando provided the Guild, and the number of allowances he claims. While Mando is fearless in gun fighting scenarios, he should be similarly confident when it comes to updating his W-4. The IRS has made it relatively easy to calculate one’s allowances in order to determine what the appropriate withholding is.
Previously, withholding allowances and total withholding was determined by walking through the worksheet provided on the 2nd page of Form W-4. In certain instances, there are additional instructions available from the IRS; however, that is relatively uncommon. When Mando decides he needs to update his withholdings, he will likely follow the workbook available at IRS.gov through the “Withholding Estimator” in order to determine what his appropriate withholdings should be, now that he is the guardian of a youngling.[44] This tool allows Mando to answer some questions to determine what his allowances are, and what his withholding should be.
Withholding allowances are a tool used by the IRS in determining appropriate withholdings based on current marginal rates. “Withholding allowance” specifically refers to an exemption from tax which reduces how much income tax an employer deducts from an employee’s paycheck. The relationship between exemptions and taxes are inverse. The more allowances claimed the less tax will be withheld from the employee’s paycheck. The inverse is also true, because the fewer exemptions claimed will result in greater tax withholding from the employee’s paycheck.
As noted, Mando now has a new dependent, so he likely has a higher number of allowances to claim, meaning he will have less tax withheld, and more cash in his pocket per paycheck.
V. Conclusion
Ultimately the end of the Season or the End of the year is always a good time to reassess things. Similarly, when there is a significant life change that occurs, it is a good time to review the items that impact your life, in particular your financial life. Now that Mando has adopted the Child, he should revisit his Form W-4 and determine if he needs to update his allowances to ensure that his tax withholdings match his estimated tax due, keeping additional dollars in his pocket, to ensure that he can keep the Child flush in fresh frogs thanks to an influx of funds.
[1] My daughters and I have a running debate about the gender of the child, as it’s never actually revealed, so we will leave it as “it” for these purposes.
[2] My wife and I also have a philosophical debate currently raging as to whether the titular “Mandalorian” is actually Mando, or the Child, as the Child ends up a Mandalorian youngling when he is placed in the guardianship of Mando in the last episode of season 1. Just another layer of credit that the show deserves. It’s really good
[3] Independent contractors and individuals who are not employees have their compensation reported via Form 1099.
[4] A savvy attorney would have structured the activities as those of independent contractors, and considering that payments are made solely based on bounties, it is realistic to conclude that the Guild and the bounty hunters that do work for it would be considered independent contractors, but for these purposes, we will assume that the guild operates as an employer, and Mando is considered an employee.
[5] See IRS “Tax Withholding for Individuals”, available at https://www.irs.gov/individuals/employees/tax-withholding (last accessed 1.19.2020).
[6] Internal Revenue Code (IRC) §3401; IRC §3509.
[7] IRC §3501; Treas. Reg. §31.6011(a)-4.
[8] Treas. Reg. §31.3402(f)(5)-1(a).
[9] IRC §3501; Treas. Reg. §31.6011(a)-4.
[10] Treas. Reg. §31.6051-1.
[11] IRC §6302(c).
[12] IRC §152(a).
[13] See Brown v. Commissioner, 61 T.C.M. 2832, 2833–34 (1991); Lerch v. Commissioner, 53 T.C.M. 1101, 1119 (1987), aff’d on other issues, 877 F.2d 624 (7th Cir. 1989).
[14] IRC §152(c)(1); Prop. Reg. §1.152-2(a).
[15] IRC §152(c)(1)(A); Prop. Reg. §1.152-2(b).
[16] IRC §152(c)(1)(B); Prop. Reg. §1.152-2(c).
[17] IRC §152(c)(1)(C); Prop. Reg. §1.152-2(d).
[18] IRC §152(c)(1)(D); Prop. Reg. §1.152-2(e). See Kho v. Commissioner, T.C. Summ. Op. 2019-18 (foster children who did not have same place of abode as the taxpayer for more than one half of tax year, and for whom taxpayer did not provide more than one half of support for calendar year in which tax year begins were not eligible qualifying children or qualifying relatives).
[19] IRC §152(c)(1)(E); Prop. Reg. §1.152-2(f).
[20] See e.g. §152(c)(2); Prop. Reg. §1.152-2(b).
[21] IRC §152(c)(2)(A).
[22] IRC §152(c)(2)(A). See also Cowan v. Commissioner, T.C. Memo 2015-85 (because Tax Court determined that T can no longer claim X as her qualifying child, X’s child cannot be considered T’s qualifying child by virtue of being descendant of X).
[23] IRC §152(c)(2)(B).
[24] IRC §152(c)(2)(B).
[25] See, e.g., O’Neal v. Wilkes, 439 S.E.2d 490 (1994). There is a full body of case law on what constitutes a foster child, so we will not focus on it here. We can just assume that Mando is the foster parent of the Child.
[26] Prop. Reg. §1.2.-2(d)(4).
[27] IRC §152(f)(1)(A)(ii) (defining “child” as “an eligible foster child of the taxpayer”).
[28] See e.g. Prop. Reg. §1.152-4(c)(1).
[29] Prop. Reg. §1.152-4(d)(2).
[30] IRC §152(f)(6)(A) (flush language); Prop. Reg. §1.152-4(e)(1).
[31] IRC §152(f)(6)(A).
[32] IRC §152(f)(6)(A)(i).
[33] IRC §152(f)(6)(A)(ii).
[34] IRC §152(f)(6)(D).
[35] The current average human lifespan is 79 years. Yoda, the only other creature in the star wars universe who appears to be of a similar species to the Child lived to be over 800 years old. If you divide 800 and 50 by ten, to get human equivalent years, the Child would be the human equivalent to 5 years old. Clearly within the age limitations for IRS purposes.
[36] IRC §152(c)(3); Prop. Reg. §1.152-2(d).
[37] IRC §152(c)(3)(A)(i).
[38] IRC §152(c)(3)(A)(ii).
[39] IRC See §22(e)(3).
[40] IRC §152(c)(2)(B).
[41] Rev. Rul. 2003-72.
[42] IRC §152(c)(3).
[43] IRC §151(d)(5), added by the 2017 tax act, Pub. L. No. 115-97, §11041.
[44] See IRS “Tax Withholding for Individuals”, available at https://www.irs.gov/individuals/employees/tax-withholding (last accessed 1.19.2020); https://www.irs.gov/individuals/tax-withholding-estimator (last accessed 1.19.2020).
