Let's clear up the major question about this form right away: it is part of the child's tax return, not the parent's.
As a result, the only numbers we can carry automatically from elsewhere in this tax return are the child's numbers, not the parent's. You have to manually enter on this return any numbers from the parent's tax return that you need.
The goal of this form is to assure that some of the child's investment income gets taxed at the parent's top tax bracket, that is, that the child's investment income gets taxed as if it were earned by the parent. This form prevents the parent from using the child as a tax shelter.
This requirement applies to investment income, such as interest and dividends, but it does not apply to the child's wages and other earned income.
There is, if you qualify, another way to do what this form does, and that is to skip this form, but to attach Form 8814 to the parent's return.
Usually Form 8814 will result in a higher tax because fewer deductions are allowed, but to be sure you should compare the results of both methods.
The following paragraphs explain in general what is going on with the calculations on this form.
As we may have mentioned, the goal of the form is to tax the child's investment income at the parent's top marginal rate. It does this by playing a little "what if" game: What if the child's investment income were added to the parent's actual income? Well, the tax would be higher--let's say $100 higher. Then this $100 becomes the tax on the child's investment income.
There's a little wrinkle: what if the parent has other children? The tax form deals with this wrinkle by figuring out how much higher the parent's tax would be if all the children's income would be added to the parent's actual income. This tax is shown on line 9.
Let's say the parent's tax would be $200 higher. This $200 then becomes the combined tax on all the children's investment income. The form then divides the $200 among the children, giving the children with more investment income a larger share.
One more wrinkle: We do not compare all the child's investment income, just the amount over some threshold (typically $1,700 in 2007). And, in case the child's taxable income is less than investment income (after reducing investment income by the $1,700), we'll use the taxable income instead.
So now we have the tax on the child's investment income.
But wait, there's more: A tax on the child's other income (earned income) is figured separately. This tax is shown on line 15. These two parts are then added together to get the child's total tax.
Are we done yet? Not quite. Just to be sure the tax collector is not missing anything, the form has us figure the tax in the normal manner on the child's actual income. This tax is shown on line 17. This tax is compared to the tax obtained using the steps above.
The child's tax due is the larger (what did you expect?) of the results of the two methods. This comparison is done on line 18.
If the child is filing Form 1040 (as opposed to Form 1040A), we calculate investment income as follows:
First we calculate self-employment income as the total of the Schedule C and Schedule F entries on Form 1040.
Then we calculate earned income as self-employment income plus wages plus other wage items for yourself (from the Mini-worksheet above Form 1040 line 7).
If the child's earned income is zero, then investment income is adjusted gross income, from Form 1040 line 37, plus any net operating loss or amount excluded on Form 2555 or 2555-EZ.
If the child's earned income is not zero, and self-employment income is zero or more, then investment income is calculated as total income (Form 1040 line 22), less earned income (calculated above), less any penalty on early withdrawal of savings (Form 1040 line 30 ), plus any net operating loss or amount excluded on Form 2555 or 2555-EZ.
If earned income is more than zero, but the child had net self-employment losses, we calculate investment income as: total income (Form 1040, line 22);plus any net operating loss or amount excluded on Form 2555 or 2555-EZ; plus self-employment income (calculated above, treated as a positive number); minus wages (from the Mini-worksheet above Form 1040 line 7); minus positive income from Schedule C (if any) from Form 1040 line 12; minus positive income from Schedule F (if any) from Form 1040 line 18; minus any penalty on early withdrawal of savings (Form 1040 line 30).
If you read all this, you may have wondered what was going on with all the additions and subtractions of Schedule C, Schedule F, and self-employment income amounts. What's happening is this: We start with total income. Then we reverse out negative self-employment income. Then we reverse out positive self-employment income and wages. The result is total income, adjusted to leave only income from investment sources.
Why go through all this? We're just following the instructions set out by the IRS in Publication 929.
The paragraphs above concerned the child who is filing Form 1040.
For a 1040A filer, it is a lot simpler. Earned income is just the Wages + Other Wage Items on 1040A, at line 7. And investment income is just total income (Form 1040A line 15) minus earned income.
We calculate line 2 as $1,700 (in 2007).
Calculation Note: If the child filed Schedule A, and $850 plus the portion of the Schedule A, line 29 , amount that is directly connected with the production of the investment income is more than $1,700, then override the $1,700 with this amount.
The reason we can not make this comparison for you is that we do not know the amount of itemized deductions that were directly connected with investment income.
If the parent and any children had net capital gains and you tell us about them, we can calculate a lower tax following a calculation similar to the one in Part IV of Schedule D. In that case, we X the box to the left of the calculated tax.
We calculate the mini-worksheet for line 15 unless either line 2 is over $1,700 or line 3 is not equal to line 5. If we do not calculate the mini-worksheet and the child used Schedule D, see IRS Publication 929 for the amounts to enter.
Here's how we calculate the mini-worksheet:
Line a is the child's net capital gain from Schedule D, line 000, reduced by ($1,700 times net capital gain divided by the amount on line 1).
Line b is the child's 28% gain from Schedule D, line 000, reduced by ($1,700 times 28% rate gain divided by the amount on line 1).
Line c is the child's unrecaptured section 1250 gain from Schedule D, line 19 , reduced by ($1,700 times unrecaptured section 1250 gain divided by the amount on line 1).
We X the box to the left of line 17 if the child has net capital gain on line 000 of Schedule D.
For the tax calculation on line 17, we use the child's actual filing status, the income on line 4, and actual Schedule D amounts. Then we use our standard tax calculation.