The Annualized Income Installment Method (AIIM) is a method used to calculate the amount of taxes payable by a business during a tax year. Taxes are typically paid in installments quarterly, but some businesses do not report uniform cash flows throughout the year. Many businesses are seasonal, which means that they earn most of their income during certain parts of the year.
What is Annualized Income Installment Method
The annualized income installment method is exactly like it sounds on the tin: it allows taxpayers to annualize tax for each period based on an estimate of income and deductions rather than in equal installments. In other words, if your estimated tax liability is $20,000 for the year, but $15,000 of it is attributable to the one quarter, the IRS allows you to figure the liability as income accumulated throughout the year.
So instead of simply dividing the tax due by four and paying $5,000 per quarter (especially if you don’t have that $5,000 because you haven’t earned it yet), you can use the annualized income installment method to figure out how much to pay as you go.
To use the annualized income installment method, you complete a worksheet at the end of each payment period and figure the payment due. You’ll also file a federal form 2210, Underpayment of Estimated Tax by Individuals, Estates, and Trusts, including Schedule AI (downloads as a pdf) with your individual federal income tax return.
There is a downside. Because the penalty is figured separately for each period, you could owe a penalty for an earlier payment period even if you make it up later. This is true even if you are due a refund when you file your income tax return.
So plan carefully. While this method can be easier on your pocketbook, it’s more time-consuming and there is increased potential for making a mistake. If you’re not sure how to calculate the tax due, it’s best to use a tax professional.
How is the Annualized Income Installment Method Used?
The annualized income installment method as used by taxpayers in the United States aids an accurate assessment of taxes. This method calculates the annual tax amount on installments in order to minimize the cost of revenue as well as fluctuation of income due to penalties.
For a taxpayer that pays quarterly, the accurate amount to be paid is realized by dividing an annual tax amount into four parts. However, to enhance the effective use of the annual income installment method, the Internal Revenue Service provides taxpayers with the necessary tools and materials for calculation.
The 505 publication of IRS contains worksheets and forms that taxpayers can use. Table 2210 IRS is also introduced but because it is a bit complex, calculations are done on the IRS datasheet. For example, if taxpayers Charles and Harrison have $200,000 as their annual estimated tax. This is divided quarterly, making a sum of $50,000 every quarter. If Charles receives his revenue with an income of 25% every quarter, tax payments can be made on schedule.
Harrison on the other hand with an imbalance income can pay 0%, 20%, 30%, and 50% in each quarter. He has four different amounts that can together make up the overall annual tax estimation. If Harrison makes payments that partly coincide in time, he can establish his donations in such a way that they can be accompanied by his income. However, calculating this contribution in this way is quite technical, it is mostly done by experts.
Calculation of the Annualized Income Installment Method
The AIIM calculation comprises several parts. Each of the components is discussed in detail below:
1. Annualization Schedule: There are three sets of schedules that can be chosen to perform the calculations. It defines the length of each of the quarters to calculate the implied annual income. It can significantly affect the amount of under and overpayment. The following table summarizes the available options. The election is made on Form 8842.
|Schedule||Period 1||Period 2||Period 3||Period 4|
|3-3-6-9 (Standard)||3 Months||3 Months||6 Months||9 Months|
|2-4-7-10 (Option 1)||2 Months||4 Months||7 Months||10 Months|
|3-8-5-11 (Option 2)||3 Months||8 Months||5 Months||11 Months|
2. Applicable Percentage (AP): The applicable percentage is the percentage of the annualized income belonging to a particular quarter. The percentages, as defined in 26 CFR 1.6552 (c)(1), are as follows:
3. Taxable Income: The taxable income is the actual income earned during the quarter. The income is annualized based on the annualization schedule, and the tax is calculated on the annualized income.
4. Annualized Income: The annualized income is calculated based on the above schedule as:
Annualized Income = (12 / No. of Months) * Taxable Income
5. Tax: It refers to the amount of tax calculated on the annualized income calculated above. It is the amount of tax that would be due if the annual income was the implied annualized income. The amount is reduced for any deductions that may apply.
6. Required Installment (RI): The required installment in the actual payable tax based on the AIIM, which is calculated as:
Required Installment = Tax * Applicable Percentage
7. Excess/Shortfall: The excess or shortfall is the difference between the actual payment made and the required installment calculated above. The excess or shortfall is carried over to the next period’s required installment.
How do I annualize my income for the annualized income installment method?
Unlike our scenario above, in real life, you will not already know your full annual tax payment when your quarterly estimated tax payment is due. Instead, you will have to estimate your annual tax payment by annualizing your income from the beginning of the year until the end of the period in which you are paying taxes. Because the “quarters” do not always fall on actual calendar quarters, year-to-date (YTD) income through May 31 is annualized by multiplying by 2.4, through Aug. 31 YTD by 1.5, and through Dec. 31 YTD by 1.