how the annualized income installment method works
the purpose of the regular installment method is to figure in quarterly tax installments it divides the annual estimated tax into four equal segments the resulting payments are appropriate for the quarterly estimated taxes of taxpayers with a steady income but this does not work as well for taxpayers whose income fluctuates some taxpayers may have a hard time finding the cash to pay estimated taxes in slower months consider for example taxpayers jane and john each of them owes 100 000 in annual estimated tax jane pays her estimated payments in four 25 000 installments per the regular installment method she evenly earned her income 25 each quarter so the quarterly portions paid her estimated tax in full and on time john s earnings were uneven with each tax quarter at 0 20 30 and 50 respectively john may have a difficult time coming up with the cash necessary to make his first and second quarter estimated tax payments when his earnings are low using the regular installment method if john were to pay less estimated tax in the first two quarters and more in the second two quarters he would owe an underpayment penalty for the first two quarters the annualized income installment method allows john to refigure his installments so they correlate to his income as he earns it it does so by annualizing john s installments over four overlapping periods each period begins on jan 1 the first period ends on march 31 the second ends on may 31 the third on aug 31 and the fourth period ends on dec 31 each period includes all the previous periods with the final period encompassing the entire year it allows john to estimate his tax payments based on his income to that point in the year in this example we know the exact percentage of john s annual earnings from each tax quarter john pays 0 in march 20 000 in may 30 000 in august and 50 000 in december john now has four installments of different amounts that when added together equal his full annual estimated tax of 100 000 john s refigured installments are now paid on time his underpayment penalties abated irs publication 505 has forms schedules and worksheets that guide taxpayers desiring to refigure their installments using the annualized income installment method 1 however figuring installments this way is complicated and best done on an irs worksheet by your favorite tax professional 