What is annualized income?
Annualized income is an estimate of the amount of money that an individual or a business generates over a period of one year. Annualized income is calculated with less than one year of data, so this is only an approximation of total income for the year. Annualized revenue figures can be useful for creating budgets and making estimated income tax payments.
Understanding annualized income
Annualized income can be calculated by multiplying earned income by the ratio of the number of months in a year divided by the number of months for which income data are available. If, for example, a consultant earned $ 10,000 in January, $ 12,000 in February, $ 9,000 in March and $ 13,000 in April, the income earned for those four months is $ 44,000. To annualize the consultant’s income, multiply $ 44,000 by 12/4 for an amount of $ 132,000.
How estimated tax payments work
Taxpayers meet their annual tax obligations by withholding tax and by making estimated tax payments quarterly. There are many sources of income that are not subject to withholding tax. Self-employment income, interest and dividend income, and capital gains are not subject to withholding tax, as are support payments and other sources of income that can be reported to a taxpayer on Form 1099. To avoid a penalty for tax underpayment, the total tax deductions and estimated tax payments must be equal to the lesser of 90% of the tax due for the year current or all of the tax due the previous year.
Examples of fluctuating annualized revenues
Calculating estimated tax payments is difficult if the taxpayer’s sources of income fluctuate over the year. Many self-employed workers generate incomes which vary considerably from month to month. Suppose, for example, that an independent seller earns $ 25,000 in the first quarter and $ 50,000 in the second quarter of the year. Higher second quarter income indicates a higher level of total income for the year and the estimated first quarter tax payment is based on a lower income level. As a result, the seller may be subject to an underpayment penalty for the first quarter.
Taking into account the annualized income payment method
To avoid underpayment penalties due to fluctuating income, IRS 2210 allows taxpayers to update income for a particular quarter and calculate estimated tax payments based on this amount. Schedule AI to Form 2210 contains a column for each quarterly period, and the taxpayer annualizes income for that period and calculates an estimated tax payment based on that estimate. Using the seller’s example, Form 2210 allows the taxpayer to annualize the first quarter income of $ 25,000 separately from the second quarter income of $ 50,000.