What is Annualized Income?

Annualized Income definition refers to the estimate of the total amount a person or a business is highly likely to generate over the course of a year. Businesses use the data that’s available for less than a year’s duration to predict the income the company can generate by the end of the year. It is important to note that the data is only an estimation.

It is assumed that the business will keep growing at the same rate for the entire year while calculating the annualized income. The major application of the annualized income is in setting budgets and identifying the income tax the company might incur for the year.

It might be a new concept for the startups, but a majority of the businesses use annualized income strategy to calculate the estimate of the tax they are supposed to pay on the annual income. In fact, the estimated tax payments are calculated nearly every quarter.

Annualized Income Formula

In order to calculate the annualized income, you must divide the total months in the year by the total number of months the income data is available for. The result must be multiplied by the total income you have earned so far.

Let’s understand it with an illustration.

Suppose your company makes a profit of INR 30,000 in January, INR 20,000 in February, and INR 50,000 in March. Now, using these figures, you can calculate the estimate of the total income your business might earn by the end of the financial year. The first step is to get the sum of your total Earnings. It will be INR 100,000 in this case.

Now, this is your total income and it must be multiplied by the total months / the months for which the income is calculated. This means you have to multiply INR 100,000 by 12/3. So, the estimated annual income is INR 400,000. Note that this is only the approximation. There is a chance you may earn higher or lower than the estimated amount. For example, if you grow your business this year, you may earn over INR 400,000.

Components of the Annualized Income

As mentioned earlier, annualized income is mainly used to calculate the total income the company or an individual might earn for the year. While it sounds like a perfect way to plan your Taxes ahead of time, this strategy may not work for those who have a fluctuating income. If you have multiple sources of income or you are running a business, then your income might fluctuate every month.

The tax payment is based on the income you earned for the quarter. So, if a self-employed person makes INR 2,00,000 in one quarter and INR 6,00,000 in the next quarter, then their Taxable Income will vary significantly. The government could implement the tax underpayment penalties for the year when you paid tax on a lower income. To avoid such penalties, the IRS Form 2210 has made it possible for all the taxpayers to calculate the tax for each quarter separately.