Handbook / Estimated tax

Annualized income installment method for uneven self-employed income

The standard approach to estimated tax assumes you earn income evenly and pay a quarter of your annual tax on each due date. Many self-employed people do not earn evenly. A landscaper earns most in summer, a tax preparer in spring, a retailer in the holiday season, and a freelancer might land one big project in the autumn. The annualized income installment method lets your payments follow your income.

How it works

Under the regular method, each required installment is a quarter of your required annual payment. Under the annualized method, the IRS explains in Publication 505 that you annualize your tax at the end of each period based on a reasonable estimate of your income, deductions and other items from the beginning of the year through the end of that period.

If you earned little early in the year, your required early installments can be smaller. If income arrives later, the later installments are larger.

The Form 2210 instructions say that if your income varied during the year because, for example, you operated your business on a seasonal basis or had a large capital gain late in the year, you may be able to lower or eliminate one or more required installments.

The four periods

Schedule AI uses cumulative periods, each including amounts from the earlier ones:

• Period (a): January 1 through March 31
• Period (b): January 1 through May 31
• Period (c): January 1 through August 31
• Period (d): the entire year

For each period, you figure income and deductions based on your accounting method. The instructions explain that if you use the cash method, used by most people, you include income actually or constructively received during the period and deductions actually paid during the period.

The all-periods rule

The Form 2210 instructions are clear: if you use Schedule AI for any payment due date, you must use it for all payment due dates. You cannot pick and choose quarters.

Claiming it on your return

The method can reduce or eliminate an underpayment penalty if your payments matched your income pattern. To use it, the instructions say you must:

1. complete Schedule AI, Part I, and Part II if necessary
2. enter the results on Form 2210, Part III
3. complete Part III to figure any penalty
4. check box C in Part II
5. attach Form 2210 and Schedule AI to your return

Schedule AI includes a part for annualized self-employment tax, so SE tax is figured on the same period basis.

Planning payments during the year

You can use the method while the year is under way, not only at filing time. Publication 505 includes an annualized estimated tax worksheet for figuring whether you can pay less for a period. At the end of each period:

1. total your income and deductions to date
2. run the annualized worksheet, or have your preparer do it
3. pay at least the resulting installment by the due date

Make sure you check the current year's worksheet and due dates on the IRS site.

When it is worth the effort

The method adds paperwork. It is most useful when:

• your income is heavily weighted toward the end of the year
• you could not have predicted a large late-year payment
• you want to keep cash in the business early in the year
• you would otherwise face a penalty for early quarters

If your income is fairly even, or you rely on the prior-year safe harbor, equal payments may be simpler.

Records you need

Because the method depends on when you received income and paid expenses, good records are essential:

• monthly income totals
• monthly deductible expenses
• dates payments were received
• estimated tax payments with dates

Monthly bookkeeping makes this straightforward; see bookkeeping for the self-employed.

Combining it with budgeting

Even if you use the annualized method, keep setting aside a share of every payment for taxes. The method changes when tax is due, not how much you owe overall. The guide to an irregular income budget explains how to keep tax money separate.

Getting help

Schedule AI is detailed. Tax software handles it, and a tax professional can run the calculation if your income is very uneven or you also have wages and other income.

If your income is uneven, the annualized method lets estimated payments follow actual income using four cumulative periods on Schedule AI; use it for all due dates, keep monthly records, and attach Form 2210 when you file.