Understanding the Annualized Income Installment Method (AIIM)

The Annualized Income Installment Method (AIIM) is a method used to calculate the amount of taxes payable by a business during a tax year. Taxes are typically paid in installments quarterly, but some businesses do not report uniform cash flows throughout the year. Many businesses are seasonal, which means that they earn most of their income during certain parts of the year.

 

 

It creates a problem as a business may not be able to meet its tax obligations in a particular quarter due to the seasonality of the business. To overcome the problem, the Annualized Income Installment Method (AIIM) is used to determine any under- or overpayment during a quarter. It helps avoid the liquidity issuesLiquidity EventA liquidity event is a process by which an investor liquidates their investment position in a private company and exchanges it for cash. The main purpose of a liquidity event is the transfer of an illiquid asset (an investment in a private company) into the most liquid asset – cash. described above.

 

Calculation of the Annualized Income Installment Method

The AIIM calculation comprises several parts. Each of the components is discussed in detail below:

 

1. Annualization Schedule: There are three sets of schedules that can be chosen to perform the calculations. It defines the length of each of the quarters to calculate the implied annual income. It can significantly affect the amount of under and overpayment. The following table summarizes the available options. The election is made on Form 8842.

SchedulePeriod 1Period 2Period 3Period 43-3-6-9 (Standard)3 Months3 Months6 Months9 Months2-4-7-10 (Option 1)2 Months4 Months7 Months10 Months3-8-5-11 (Option 2)3 Months8 Months5 Months11 Months

 

2. Applicable Percentage (AP): The applicable percentage is the percentage of the annualized income belonging to a particular quarter. The percentages, as defined in 26 CFR 1.6552 (c)(1), are as follows:

QuarterApplicable PercentageQ125%Q250%Q375%Q4100%

 

3. Taxable Income: The taxable income is the actual income earned during the quarter. The income is annualized based on the annualization schedule, and the tax is calculated on the annualized income.

 

4. Annualized Income: The annualized income is calculated based on the above schedule as:

 

Annualized Income = (12 / No. of Months) * Taxable Income

 

5. Tax: It refers to the amount of tax calculated on the annualized income calculated above. It is the amount of tax that would be due if the annual income was the implied annualized income. The amount is reduced for any deductions that may apply.

 

6. Required Installment (RI): The required installment in the actual payable tax based on the AIIM, which is calculated as:

 

 Required Installment = Tax * Applicable Percentage

 

7. Excess/Shortfall: The excess or shortfall is the difference between the actual payment made and the required installment calculated above. The excess or shortfall is carried over to the next period’s required installment.

A sample calculation of how the AIIM is used to calculate the tax incidence is detailed in the table below:

 

Annualized Income Installment Method*Option2Method2-4-7-10InstallmentMonthsTaxable IncomeAnnualized IncomeTaxAPRequired InstallmentPaymentExcess/(Shortfall)12$25,000$150,000 $41,75025% $10,437.50 $15,000 $4,562.5024$64,000$192,000 $58,13050% $18,627.50 $19,563 $935.0037$125,000$214,286 $66,82175% $21,050.75 $15,935 $-5,115.75410$175,000$210,000 $65,150100% $15,034.25 $9,884 $-5,150.00

*Example Reproduced from 26 C.F.R. 1.6655-2)

 

In the example above, the annualization schedule used is 2-4-7-10 months, the payment is the amount fixed at $15,000 every quarter, and the adjustments to the payment is based on the excess and shortfall in the previous period.

 

End of the Year Calculation

At the end of the year, if there is a shortfall in taxes paid, an addition to tax is paid. The amount is calculated on an actual/365 basis at the underpayment rate, as given by 26 U.S.C. 6621 (a)(2):

 

Addition to Tax = Shortfall * (Actual Days / 365) * Underpayment Rate

 

In our case, we assume the underpayment rate to be 8% and 90 days in each quarter, then the addition to tax is given by:

Q1 = 0 (no underpayment)

Q2 = 0 (no underpayment)

Q3 = $5,116 * 90/365 * 8% = $102

Q4 = $5,150 * 90/365 * 8% = $103

Hence, the total addition to tax for the year is $205 due to the shortfall in the last two quarters.

 

Additional Resources

CFI is the official provider of the Commercial Banking & Credit Analyst (CBCA)™Program Page - CBCAGet CFI's CBCA™ certification and become a Commercial Banking & Credit Analyst. Enroll and advance your career with our certification programs and courses. certification program, designed to transform anyone into a world-class financial analyst.

In order to help you become a world-class financial analyst and advance your career to your fullest potential, these additional resources will be very helpful:

• Annual IncomeAnnual IncomeAnnual income is the total value of income earned during a fiscal year. Gross annual income refers to all earnings before any deductions are
• Corporate vs Personal Income TaxCorporate vs Personal Income TaxIn this article, we will discuss corporate vs personal income tax. Corporate tax is an expense of a business (cash outflow) levied by the government
• Accounting for Income TaxesAccounting For Income TaxesIncome taxes and their accounting is a key area of corporate finance. There are several objectives in accounting for income taxes and optimizing a company's valuation.
• Taxable IncomeTaxable IncomeTaxable income refers to any individual's or business’ compensation that is used to determine tax liability. The total income amount or gross income is used as the basis to calculate how much the individual or organization owes the government for the specific tax period.