Using the Annualized Income Installment Method to Pay Estimated Tax

Fluctuating income is a common occurrence when you’re self-employed. Uneven income can make it hard to calculate and pay estimated tax. If you underpay, the IRS will penalize you, but overpaying means you won’t see that money until the next tax cycle when you get it as a refund.

The annualized income installment method is a good way to avoid underpayment penalties and pay 1099 contractor taxes on earned income rather than estimated income. So if you don’t always have a steady stream of 1099 income, this method is for you.

Self-employed taxes and the AIIM

The 1099 tax rate is 15.3% of earned income, with 12.4% for Social Security taxes and 2.9% for Medicare taxes. The self-employed tax rate is quite high as 1099 workers pay the entire FICA tax, unlike W-2 employees who only pay half.

However, the employer portion of the FICA tax (7.65%) can be deducted from your federal income tax, so it’s not so bad. You’ll also need to estimate your annual tax liability by April. This is because liabilities over $1,000 have to be paid in quarterly installments.

If you also work a W-2 job, remember to add your income tax liability to your estimated tax calculations. An estimated tax calculator can easily help you do this as long as you know what your income will be for the whole year.

Estimated quarterly tax payments are usually made in four equal parts. The quarterly tax dates for 2023 are April 18, June 15, September 15 and January 16. Having uneven income can make it difficult to make equal payments every time, as you might make less money in one quarter and not have enough to make the payment.

Enter the annualized income installment method (AIIM). It was introduced by the IRS to help 1099 individuals who didn’t know how much money they were going to earn in a year. This could be because they work for multiple clients, their job demand is seasonal or they tend to get random one-off payments for projects.

How does annualized income help calculate estimated tax?

The AIIM calculates income by “annualizing” it. This just means estimating your annual income by looking at your earnings for a certain period. You need to break down the year into four periods to use this method.

You also have to calculate your adjusted gross income for each period and multiply it by a set “annualization amount.” Each amount represents how much of the tax year is remaining. For example, Period a’s annualization amount is “4” because it is a fourth of the year.

The annualization periods and amounts are already filled out in Schedule AI of Form 2210, so you don't have to remember them. You can calculate your AGI by deducting write-offs from your earnings to calculate your net income. A tax deduction calculator can help you find relevant self-employment deductions.

You should also deduct health insurance premiums, retirement contributions and half your SE tax from your net income on Schedule 1 (Form 1040). The resulting number is your AGI.

Real-life example of the AIIM

Say you own a candle-making business. You know that your earned income will be over $400 in 2023, so you have to pay SE tax. Your income tends to fluctuate throughout the year, and you decide to use the AIIM to pay estimated taxes.

From January to March 31, your AGI was $15,000, which you calculated using a small business tax calculator. Multiplying this by 4 (amount for Period a) gives you an annualized income of $60,000. So you make the first estimated tax payment on April 18 based on $60,000 using Form 1040-ES.

• Annualized income for Period (a): 15,000 x 4 = $60,000

April and May turn out to be pretty lucrative months, and your AGI totals $12,000. For Period (b), your annualized income is $64,800. This income amount is what you use to make the June 15 tax payment.

• Annualized income for Period (b): (15,000 + 12,000) x 2.4 = $64,800

Business slows in the summer months and your AGI falls to $8,000. This brings your annualized income for Period (c) down to $52,500. This method allowed you to pay less estimated tax on September 15 when your income fell and save your money.

• Annualized income for Period (c): (15,000 + 12,000 + 8,000) x 1.5 = $52,500

Finally, your business picks back up in the fall and winter months, and you get an AGI of $18,500. So Period (d)’s annualized income is $53,500 which you’ll use to calculate and pay quarterly tax on January 16.

• Annualized income for Period (d): (15,000 + 12,000 + 8,000 + 18,500) x 1 = $53,500

As you can see, the AIIM can be quite tedious. Business deductions are even more important when using this method as they directly affect your tax payments. If you’re busy working on your business, you might not have enough time to track all your expenses.  

If you use FlyFin, you can link your expenses, let A.I. do all the work and find tax deductions. If you have any questions or need help with your returns, you can reach out to a CPA for unlimited support on the app.