What Is the Annualized Income Installment Method?

Taxpayers who are self-employed typically pay quarterly installments of their estimated tax in four even amounts as figured by the regular installment method. Additionally, taxpayers should pay estimated taxes if they receive substantial dividends, interest, alimony, or other forms of income that are not subject to income tax withholding.

When a taxpayer has a fluctuating income, it often causes them to underpay on one or more of the quarterly estimates leading to underpayment penalties. The annualized income installment method calculates the taxpayer’s estimated tax installment payments and helps to decrease underpayment and corresponding underpayment penalties related to fluctuating income. Through the use of the annualized income installment method, taxpayers may estimate their taxes based on known information from the beginning of the tax year through the end of the period paid.

How the Annualized Income Installment Method Works

The purpose of the regular installment method is to figure in quarterly tax installments. It divides the annual estimated tax into four equal segments. The resulting payments are appropriate for the quarterly estimated taxes of taxpayers with a steady income, but this does not work as well for taxpayers whose income fluctuates. Some taxpayers may have a hard time finding the cash to pay estimated taxes in slower months.

Consider, for example, taxpayers Jane and John. Each of them owes $100,000 in annual estimated tax. Jane pays her estimated payments in four $25,000 installments per the regular installment method. She evenly earned her income, 25% each quarter, so the quarterly portions paid her estimated tax in full and on time. 

John’s earnings were uneven, with each tax quarter at 0%, 20%, 30%, and 50%, respectively. John may have a difficult time coming up with the cash necessary to make his first and second quarter estimated tax payments when his earnings are low. Using the regular installment method, if John were to pay less estimated tax in the first two quarters and more in the second two quarters, he would owe an underpayment penalty for the first two quarters.

The annualized income installment method allows John to refigure his installments, so they correlate to his income as he earns it. It does so by annualizing John’s installments over four overlapping periods. Each period begins on Jan. 1. The first period ends on March 31, the second ends on May 31, the third on Aug. 31, and the fourth period ends on Dec. 31. Each period includes all the previous periods, with the final period encompassing the entire year. It allows John to estimate his tax payments based on his income to that point in the year.

In this example, we know the exact percentage of John’s annual earnings from each tax quarter. John pays $0 in March, $20,000 in May, $30,000 in August, and $50,000 in December. John now has four installments of different amounts that, when added together, equal his full annual estimated tax of $100,000. John’s refigured installments are now paid on time, his underpayment penalties abated.

IRS Publication 505 has forms, schedules, and worksheets that guide taxpayers desiring to refigure their installments using the annualized income installment method. However, figuring installments this way is complicated and best done on an IRS worksheet by your favorite tax professional.

What Is the Amortization of Intangibles?

Amortization of intangibles, also simply known as amortization, is the process of expensing the cost of an intangible asset over the projected life of the asset for tax or accounting purposes. Intangible assets, such as patents and trademarks, are amortized into an expense account called amortization. Tangible assets are instead written off through depreciation. The amortization process for corporate accounting purposes may differ from the amount of amortization used for tax purposes.

Understanding the Amortization of Intangibles

For tax purposes, the cost basis of an intangible asset is amortized over a specific number of years, regardless of the actual useful life of the asset (as most intangibles don’t have a set useful life). The Internal Revenue Service (IRS) allows intangibles to be amortized over a 15-year period if it’s one of the ones included in Section 197.

Intangible assets are non-physical assets that can be assigned an economic value. Intellectual property (IP) is considered to be an intangible asset and is a broad term that encompasses most intangible assets. Most IP is covered under Section 197. Examples of these Section 197 intangible assets include patents, goodwill, trademarks, and trade and franchise names.

Not all IP is amortized over the 15-year period set by the IRS, however. There are certain exclusions, such as software acquired in a transaction that is readily available for purchase by the general public, subject to a nonexclusive license, and has not been substantially modified. In those cases and select others, the intangibles are amortized under Section 167.

Special Considerations

When a parent company purchases a subsidiary company and pays more than the fair market value (FMV) of the subsidiary’s net assets, the amount over fair market value is posted to goodwill (an intangible asset). IP is initially posted as an asset on the firm’s balance sheet when it is purchased.

IP can also be internally generated by a company’s own research and development (R&D) efforts. For instance, a company may win a patent for a newly developed process, which has some value. That value, in turn, increases the value of the company and so must be recorded appropriately.

In either case, the process of amortization allows the company to write off annually a part of the value of that intangible asset according to a defined schedule.

Amortization vs. Depreciation

Assets are used by businesses to generate revenue and produce income. Over a period of time, the costs related to the assets are moved into an expense account as the useful life of the asset dwindles. By expensing the cost of the asset over a period of time, the company is complying with GAAP, which requires the matching of revenue with the expense incurred to generate the revenue.

Tangible assets are expensed using depreciation, and intangible assets are expensed through amortization. Depreciation generally includes a salvage value for the physical asset—the value that the asset can be sold for at the end of its useful life. Amortization doesn’t take into account a salvage value.

Types of Amortization

For accounting (financial statement) purposes, a company can choose from six amortization methods: straight line, declining balance, annuity, bullet, balloon, and negative amortization. There are only four depreciation methods that can be used for accounting purposes: straight line, declining balance, sum-of-the-years’ digits, and units of production.

For tax purposes, there are two options for amortization of intangibles that the IRS allows. These are straight line and the income forecast method. The income forecast method can be used instead of the straight-line method if the asset is: motion picture films, videotapes, sound recordings, copyrights, books, or patents. For depreciation of physical assets, the IRS only allows the Modified Accelerated Cost Recovery System (MACRS).

Example of Amortization

Assume, for example, that a construction company buys a $32,000 truck to contractor work, and that the truck has a useful life of eight years. The annual depreciation expense on a straight-line basis is the $32,000 cost basis minus the expected salvage value—in this case, $4,000—divided by eight years. The annual deprecation for the truck would be $3,500 per year, or ($32,000 – $4,000) ÷ 8.

On the other hand, assume that a corporation pays $300,000 for a patent that allows the firm exclusive rights over the intellectual property for 30 years. The firm’s accounting department posts a $10,000 amortization expense each year for 30 years.

Both the truck and the patent are used to generate revenue and profit over a particular number of years. Since the truck is a physical asset, depreciation is used, and since the rights are intangible, amortization is used.

What is Accountant Responsibility?

Accountant responsibility is the ethical responsibility an accountant has to those who rely on their work. According to the American Institute of Certified Public Accountants (AICPA), accountants have a duty to serve the public interest and uphold the public trust in the profession. An accountant has a responsibility to his clients, his company’s managers, investors, and creditors, as well as to outside regulatory bodies. Accountants are responsible for the validity of the financial statements they work on, and they must perform their duties following all applicable principles, standards, and laws.

Understanding Accountant Responsibility

Accountant responsibility varies slightly based on the accountant’s relationship with the tax filer or business in question. Independent accountants with some clients see confidential information, ranging from personal Social Security numbers to business sales data, and must observe accountant-client privilege. They cannot share private personal or business data with competitors or others.

Accountants who work for accounting firms also have a responsibility to keep information private, but they also have a responsibility to their firm. Namely, they must accurately track their hours and tasks completed. For example, an accountant performing an audit should only record items he has actually completed, rather than pretending he has completed items he has not in order to speed up the process or bolster his logged hours.

If an accountant works directly for a business, as an in-house accountant, he has access to information many others in the company do not, ranging from payroll figures to news about staff layoffs, and he also has to treat this information discretely. In addition to having a responsibility to the people who work at the company, in-house accountants are also responsible to stockholders and creditors. If accountants do not uphold their responsibilities, it can have a broad effect on the accounting industry and even the financial markets.

Accountant Responsibility and the Internal Revenue Service

Although accountants have a great deal of responsibility to their clients, if the Internal Revenue Service finds an error in an individual’s tax return, it does not hold the tax preparer or accountant responsible. Rather, the IRS adjusts the return and holds the taxpayer responsible for the additional tax, fees, and penalties. However, an individual who has been wronged by an accountant’s misconduct can bring a claim of negligence against the accountant based on the fact the accountant breached his duty to the client and caused personal or financial damages.

The IRS also accepts complaints about tax return preparers who have committed fraud, and anyone with an issue may submit a complaint using Form 14157, Complaint: Tax Return Preparer. In-house accountants who cook the books or purposefully include erroneous data in their company’s tax returns or accounting documents are responsible for misconduct and may even be criminally liable.

Accountant Responsibility and External Audits

According to the Public Company Accounting Oversight Board (PCAOB), accountants performing external audits have the responsibility to obtain reasonable assurance about whether the client’s financial statements are free of material misstatement, whether caused by error or fraud. The Sarbanes-Oxley Act of 2002 (SOX) added new audit responsibilities relating to fraud. External auditors now have to certify that a client’s internal controls are adequate in addition to expressing an opinion on the financial statements.

What Is an Alternative Trading System (ATS)?

An alternative trading system (ATS) is a trading venue that is more loosely regulated than an exchange. ATS platforms are often used to match large buy and sell orders among its subscribers. The most widely used type of ATS in the United States are electronic communication networks (ECNs)—computerized systems that automatically match buy and sell orders for securities in the market.

Understanding an Alternative Trading System (ATS)

ATS account for much of the liquidity found in publicly traded issues worldwide. They are known as multilateral trading facilities in Europe, ECNs, cross networks, and call networks. Most ATS are registered as broker-dealers rather than exchanges and focus on finding counterparties for transactions.

Unlike some national exchanges, ATS do not set rules governing the conduct of subscribers or discipline subscribers, other than by excluding them from trading. They are important in providing alternative means to access liquidity.

Institutional investors may use an ATS to find counterparties for transactions, instead of trading large blocks of shares on national stock exchanges. These actions may be designed to conceal trading from public view since ATS transactions do not appear on national exchange order books. The benefit of using an ATS to execute such orders is that it reduces the domino effect that large trades might have on the price of an equity.

Criticisms of Alternative Trading Systems (ATS)

These trading venues must be approved by the SEC. In recent years, regulators have stepped up enforcement actions against ATS for infractions such as trading against customer order flow or making use of confidential customer trading information. These violations may be more common in ATS than national exchanges because ATS face fewer regulations.

Dark Pools

A hedge fund interested in building a large position in an equity may use an ATS to prevent other investors from buying in advance. ATS used for these purposes may be referred to as dark pools.

Dark pools entail trading on ATS by institutional orders executed on private exchanges. Information about these transactions is mostly unavailable to the public, which is why they are called “dark.” The bulk of dark pool liquidity is created by block trades facilitated away from the central stock market exchanges and conducted by institutional investors (primarily investment banks).

Although they are legal, dark pools operate with little transparency. As a result, dark pools, along with high-frequency trading (HFT), are oft-criticized by those in the finance industry; some traders believe that these elements convey an unfair advantage to certain players in the stock market.

Regulation of Alternative Trading Systems (ATS)

SEC Regulation ATS established a regulatory framework for ATS. An ATS meets the definition of an exchange under federal securities laws but is not required to register as a national securities exchange if the ATS operates under the exemption provided under Exchange Act Rule 3a1-1(a). To operate under this exemption, an ATS must comply with the requirements in Rules 300-303 of Regulation ATS.

To comply with Regulation ATS, an ATS must register as a broker-dealer and file an initial operation report with the Commission on Form ATS before beginning operations. An ATS must file amendments to Form ATS to provide notice of any changes to its operations, and must file a cessation of operation report on Form ATS if it closes. The requirements for filing reports using Form ATS is in Rule 301(b)(2) of Regulation ATS. These requirements include mandated reporting of books and records.

In recent times, there have been moves to make ATS more transparent. For example, the SEC amended Regulation ATS to enhance “operational transparency” for such systems in 2018. Among other things, this entails filing detailed public disclosures to inform the general public about potential conflicts of interest and risks of information leakage. ATS are also required to have written safeguards and procedures to protect subscribers’ trading information.

The SEC formally defines an alternative trading system as “any organization, association, person, group of persons, or systems (1) that constitutes, maintains, or provides a market place or facilities for bringing together purchasers and sellers of securities or for otherwise performing with respect to securities the functions commonly performed by a stock exchange within the meaning of Rule 3b-16 under the Exchange Act; and (2) that does not (i) set rules governing the conduct of subscribers other than the conduct of such subscribers’ trading on such organization, association, person, group of persons, or system, or (ii) discipline subscribers other than by exclusion from trading.”