Annualized Income Installment Method (AIIM)
Calculation of the amount of tax payable.
What is the Annualized Income Installment Method (AIIM)?
The Annualized Income Installment Method (AIIM) calculates the amount of tax payable, usually used by self-employed individuals. Even used by firms for figuring out how much tax a firm owes in a given tax year.
Although taxes are frequently paid by some taxpayers quarterly, some firms may not disclose consistent cash flows throughout the year.
This method facilitates the individual business owners and firms whose income is affected by seasonality or cyclical revenue intervals to assess the amount of tax payable accurately.
However, due to the seasonality effect, the taxpayers become liable to the government, leading them to non-payment penalties.
How the Annualized Income Installment Method Works
Many companies are periodic, meaning that most of their revenue is generated during specific times of the year. It causes an issue since a company might be unable to pay its taxes in a given quarter because of the industry's seasonality.
As a result, a taxpayer's shifting income frequently results in underpaying on one or more of the quarterly estimates, resulting in underpayment penalties.
Any under- or overpayment during a quarter is determined using the Annualized Income Installment Method (AIIM) to solve the issue.
Taxpayers can estimate their taxes using the annualized income installment method by using data from the start of the tax year to the conclusion of the period paid. It assists in avoiding liquidity problems.
In other words, The regular installment system is intended to account for quarterly tax installments. The expected yearly tax is divided into four equal parts. The resultant payments are suitable for the anticipated quarterly taxes for taxpayers with a consistent income.
However, this does not work as well for taxpayers whose income varies. In the slower months, some taxpayers could struggle to find the money to pay anticipated taxes.
Example Of Annualized Income Installment Method
For example, suppose Jennifer and Sami have $88,000 in annual estimated tax. Jennifer pays what she owes in 4 evenly divided payments of $22,000. The quarterly parts paid her anticipated tax in full and on schedule since she distributed her money equally, earning 25% each quarter.
On the other hand, Sami's profits were unequal, with each tax quarter equaling 10%, 15%, 20%, and 55% of his total earnings.
As a result, when his income is modest, Sami can struggle to come up with the money needed to make his first and second-quarter anticipated tax payments.
Using the standard installment approach, Sami would have to pay an underpayment penalty for the first two quarters if he paid less estimated tax in the first two quarters and more in the second two quarters.
Sami can recalculate his installments using the annualized income installment technique to correspond to his income as he earns.
It does this by dividing Sami's payments into four overlapping yearly periods. Every period starts on January 1st. March 31 is the end of the first period, May 31 is the end of the second, August 31 is the end of the third, and December 31 is the end of the fourth.
With the last period covering the whole year, each period encompasses all preceding periods. Sami may make an educated guess of his tax obligations based on his earnings up to that point in the year.
We know the precise share of Sami's yearly income from each tax quarter. Sami makes payments of $8,800 in March, $13,200 in May, $17,600 in August, and $48,400 in December.
Sami now owes four installments for $88,000 in anticipated taxes. His underpayment penalties have been removed, and his recalculated payments are now paid on time.
Calculation of the Annualized Income Installment Method
The calculation of the AIIM is composed of multiple parts:
1. Annualization schedule
Three different schedule sets are available for the computations. To get the inferred yearly revenue, it specifies each quarter. Therefore, it has a big impact on underpayment and overpayment amounts. The choice is entered on Form 8842.
There exists 3 options:
- The first option is the standard one which allocates 3 months for the first and second period, 6 months for the third period, and 9 months for the fourth period. (9 months after the start on the duration of getting the revenue)
- The second option is the standard one which allocates 2 months for the first, 4 months for the second period, 7 months for the third period, and 10 months for the fourth period.
- The third option is the standard one which allocates 3 months for the first, 8 months for the second period, 5 months for the third period, and 11 months for the fourth period.
2. Applicable percentage (AP)
It is the proportion of annualized income that belongs to a specific quarter. The percentages are taken from 26 CFR 1.6552 (c)(1).
- For quarter 1, the applicable percentage is 25%
- For quarter 2, the applicable percentage is 50%
- For quarter 3, the applicable percentage is 75%
- For quarter 4, the applicable percentage is 100%
3. Taxable Income
What is taxed is the actual income earned over the quarter. The income is annualized using the annualization schedule, and the annualized income is then used to calculate the tax.
4. Annualized Income
The annualized income is calculated through the following formula and based on the standards listed above.
Annualized Income = (12 / # of Months) * Taxable Income
To illustrate, consider your taxable income is $12,000 and the number of months is 11, the annualized income becomes: (12/11)*12,000= $13,090.90
5. Tax
It alludes to the amount of tax deducted from the previously determined yearly income. It is the tax owed if the yearly income were the suggested annualized income. Any applicable deductions are subtracted from the total amount.
6. Required Installment (RI)
The needed payment for the real payable tax using the AIIM is determined as follows:
Required Installment = Tax * Applicable Percentage
For example, if the tax is $1,280 and the applicable percentage is 30% then the required installment becomes: 1,280 x 30% = 1,280 x 0.3 = $384
7. Excess/Shortfall
The discrepancy between the actual amount paid and the needed installment determined above is known as the excess or shortfall. Therefore, the surplus or shortfall will increase the required installment for the following period.
Researched and authored by Ely Karam | LinkedIn
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