What is 'Annualized Income'

Annualized income is an estimate of the sum of money that an individual or a business generates during a year's time. Annualized income is calculated with less than one year's worth of data, so it is only an approximation of total income for the year, and annualized income figures can be helpful for creating budgets and making estimated income tax payments.

BREAKING DOWN 'Annualized Income'

Annualized income can be calculated by multiplying the earned income figure by the ratio of (number of months in a year) divided by (number of months of income data 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 earned income figure for those four months totals $44,000. To annualize the consultant's income, multiply $44,000 by 12/4 to equal $132,000.

How Estimated Tax Payments Work

Taxpayers pay annual tax liabilities through tax withholdings and by making estimated tax payments each quarter, and many sources of income are not subject to tax withholding. Income from self-employment, interest and dividend income and capital gains are not subject to tax withholdings, along with alimony and some other sources of income that may be reported to a taxpayer on Form 1099. To avoid a penalty for tax underpayment, the total tax withholdings and estimated tax payments must equal the lesser of 90% of the tax owed for the current year or the full tax owed the previous year.

Examples of Income That Fluctuates

Computing estimated tax payments is difficult if the taxpayer’s income sources fluctuate during the year, and many self-employed people generate income that varies greatly from one month to the next. Assume, for example, that a self-employed salesperson earns $25,000 during the first quarter and $50,000 in the second quarter of the year. The higher income in the second quarter indicates a higher total level of income for the year, and the first quarter’s estimated tax payment is based on a lower level of income. As a result, the salesperson may be assessed an underpayment penalty for the first quarter.

Factoring in the Annual Income Installment Method

To avoid the underpayment penalties due to fluctuating income, the IRS Form 2210 allows the taxpayer to annualize income for a particular quarter and compute the estimated tax payments based on that amount. Schedule AI of Form 2210 provides a column for each quarterly period, and the taxpayer annualizes the income for that period and computes an estimated tax payment based on that estimate. Using the salesperson example, Form 2210 allows the taxpayer to annualize the $25,000 first quarter income separately from the $50,000 second quarter income.

RELATED TERMS
  1. Net Income - NI

    A company's total earnings (or profit). Net income is calculated ...
  2. Federal Income Tax

    A federal income tax is levied by the United States Internal ...
  3. Income Tax

    A tax that governments impose on financial income generated by ...
  4. Tax Return

    A tax return is a form(s) filed with a taxing authority which ...
  5. Tax Base

    The assessed value of a set of assets, investments or income ...
  6. IRS Publication 514

    A document published by the Internal Revenue Service that provides ...
Related Articles
  1. Taxes

    Estimated Taxes Tripping Up More Filers

    If your working as an independent contractor, making sure you cover your bill for estimated taxes is important for avoiding a tax penalty.
  2. Taxes

    Confused About Estimated Tax Deadlines for 2016?

    If you run a business or have investment income, pay attention to this year's estimated tax deadlines. Here are the details, and what's new for 2016.
  3. Taxes

    7 Ways To Avoid Self-Employed Tax Penalties

    If you follow these methods for calculating estimated tax payments, you could minimize your chances of incurring penalties.
  4. Taxes

    Understanding The U.S. Tax Withholding System

    Understanding the origins of our tax withholding system is crucial to getting the most out of it.
  5. Personal Finance

    3 Common Tax Questions Answered

    We clarify some rules that often puzzle taxpayers.
  6. Taxes

    Form 9465: Don't Pay Your Back Taxes Without It

    This form can lighten your tax load if you owe Uncle Sam. And you can often apply online.
  7. Taxes

    Estimated Taxes: Back To Basics

    Will you owe estimated taxes for the year? Here are some rules that apply and tips on avoiding any associated penalties.
  8. Taxes

    Why Do So Many People Fall Behind On Their Taxes?

    Despite the threat of owing thousands of dollars to possibly the most feared organization in the U.S., millions of Americans continue to fall behind on their taxes.
  9. Taxes

    How to Reduce Risk With Tax Diversification

    Is your retirement income adequately diversified from a tax standpoint?
  10. Taxes

    Comparing Regressive, Proportional and Progressive Taxes

    Learn about the basic differences between three common tax systems.
RELATED FAQS
  1. What is the difference between gross income and earned income?

    The difference between earned income and gross income is an important one come tax time. Read Answer >>
Hot Definitions
  1. Treasury Yield

    Treasury yield is the return on investment, expressed as a percentage, on the U.S. government's debt obligations.
  2. Return on Assets - ROA

    Return on assets (ROA) is an indicator of how profitable a company is relative to its total assets.
  3. Fibonacci Retracement

    A term used in technical analysis that refers to areas of support (price stops going lower) or resistance (price stops going ...
  4. Ethereum

    Ethereum is a decentralized software platform that enables SmartContracts and Distributed Applications (ĐApps) to be built ...
  5. Cryptocurrency

    A digital or virtual currency that uses cryptography for security. A cryptocurrency is difficult to counterfeit because of ...
  6. Financial Industry Regulatory Authority - FINRA

    A regulatory body created after the merger of the National Association of Securities Dealers and the New York Stock Exchange's ...
Trading Center