What is 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 issues 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.
|Schedule||Period 1||Period 2||Period 3||Period 4|
|3-3-6-9 (Standard)||3 Months||3 Months||6 Months||9 Months|
|2-4-7-10 (Option 1)||2 Months||4 Months||7 Months||10 Months|
|3-8-5-11 (Option 2)||3 Months||8 Months||5 Months||11 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:
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*|
|Installment||Months||Taxable Income||Annualized Income||Tax||AP||Required Installment||Payment||Excess/(Shortfall)|
*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.
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