Annualized Income Installment Method

The annualized Income installment method purpose is to prevent all sorts of underpayment penalties and make it easier for the individual or company to finance their Taxes. Usually, underpayment issues arise because of fluctuating incomes. People who are self-employed or those who have any kind of job that results in fluctuating incomes are highly likely to face the Underpayment Penalty issue. Each taxpayer has to pay tax every quarter.

Basically, the annual income of the person is divided into quarters, allowing the taxpayers to make the payments in installments, instead of one lump sum. While this may be a perfect option for a full-time employee to pay their taxes in a timely fashion, it isn’t always a reliable choice for those who have multiple sources of income. As your income keeps fluctuating every quarter, there is a chance you may end up with the underpayment. Now, the annualized income installment method can help the self-employed individuals, businesses, and others to get the best estimate of their taxes.

How Does the Annualized Income Installment Method Work?

As mentioned earlier, the annualized income installment method help divide your annual tax payments into four equal segments. It helps you get the precise estimate of the quarterly tax you are supposed to pay to the government. Then again, the method is designed for only those with stable income. If you are in a profession or a business where you could expect a stable income every quarter, then the annualized income installment method is going to work for you. It will help you get the quarterly estimated tax. Let’s understand this with an example.

Example

Suppose you and your friend owe INR 1,00,000 annual tax to the government. Now, the tax is divided into four equal parts, i.e. INR 25,000 for each quarter. You earn a stable income every month and pay your tax in a timely manner and in full. So, this avoids any kind of underpayment penalty. Your friend, on the other hand, earns income from multiple sources. They have a fluctuating income every quarter, so they pay an uneven amount on tax installments.

Let’s say your friend has an uneven income for every quarter. It is 0% for the first quarter, 20% for the next, and 30% and 50% for the remaining two. While it may be easy for your friend to pay taxes in the last two quarters, they are going to have a hard time financing the tax payments for the first two quarters when their income is low. The only option your friend has here is to pay nothing in the first quarter and a small percentage of tax in the second one. This may result in tax underpayment penalties. Here, the annualized income installment method will make it possible for your friend to manage his funds in such a way that he can pay tax installments from the income.