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 an Autonomous Expenditure?

An autonomous expenditure describes the components of an economy’s aggregate expenditure that are not impacted by that same economy’s real level of income. This type of spending is considered automatic and necessary, whether occurring at the government level or the individual level. The classical economic theory states that any rise in autonomous expenditures will create at least an equivalent rise in aggregate output, such as GDP, if not a greater increase.

Understanding Autonomous Expenditure

An autonomous expenditure obligation must be met regardless of income. It is considered independent in nature, as the need does not vary with incomes. Often, these expenses are associated with the ability to maintain a state of autonomy. Autonomy, in regard to nations, includes the ability to be self-governing. For individuals, it refers to the ability to function within a certain level of societally acceptable independence.

To be considered an autonomous expenditure, the spending must generally be deemed necessary to maintain a base level of function or, in an individual sense, survival. Often, these expenses do not vary regardless of personal disposable income or national income. Autonomous expenditure is tied to autonomous consumption, including all of the financial obligations required to maintain a basic standard of living. All expenses beyond these are considered part of induced consumption, which is affected by changes in disposable income.

In cases in which personal income is insufficient, autonomous expenses still must be paid. These needs can be met through the use of personal savings, consumer borrowing mechanisms such as loans and credit cards, or various social services.

Autonomous Expenditures and Income Levels

While the obligations that qualify as autonomous expenditures do not vary, the amount of income directed toward them can. For example, in an individual sense, the need for food qualifies as an autonomous expenditure, though the need can be fulfilled in a variety of manners, ranging from the use of food stamps to eating every meal at a five-star restaurant. Even though income level may affect how the need is met, the need itself does not change.

Governments and Autonomous Expenditures

The vast majority of government spending qualifies as autonomous expenditures. This is due to the fact that the spending often relates strongly to the efficient running of a nation, making some of the expenditures required in order to maintain minimum standards.

Factors Affecting Autonomous Expenditures

Technically, autonomous expenditures are not affected by external factors. In reality, however, several factors can affect autonomous expenditures. For example, interest rates have a significant effect on consumption in an economy. High interest rates can tamp down on consumption while low interest rates can spur it. In turn, this affects spending within an economy.

Trade policies between countries can also affect autonomous expenditures made by their citizens. If a producer of cheap goods imposes duties on exports, then it would have the effect of making finished products for outside geographies more expensive. Governments can also impose controls on an individual’s autonomous expenditures through taxes. If a basic household good is taxed and no substitutes are available, then the autonomous expenditure pertaining to it may decrease.

Examples of Autonomous Expenditure

Some of the spending classes that are considered independent of income levels, which can be counted as either individual income or taxation income, are government expenditures, investments, exports, and basic living expenses such as food and shelter.

What Is After-Tax Income?

After-tax income is the net income after the deduction of all federal, state, and withholding taxes. After-tax income, also called income after taxes, represents the amount of disposable income that a consumer or firm has available to spend.

Understanding After-Tax Income

Most individual tax filers use some version of the IRS Form 1040 to calculate their taxable income, income tax due, and after-tax income. To calculate after-tax income, the deductions are subtracted from gross income. The difference is the taxable income, on which income taxes are due. After-tax income is the difference between gross income and the income tax due. 

Consider the following example: Abi Sample earns $30,000 and claims $10,000 in deductions, resulting in a taxable income of $20,000. Their federal income tax rate is 15%, making the income tax due $3,000. The after-tax income is $27,000, or the difference between gross earnings and income tax ($30,000 – $3,000 = $27,000).

Individuals can also account for state and local taxes when calculating after-tax income. When doing this, sales tax and property taxes are also excluded from gross income. Continuing with the above example, Abi Sample pays $1,000 in state income tax and $500 in municipal income tax resulting in an after-tax income of $25,500 ($27,000 – $1500 = $25,500).

Calculating After-Tax Income for Businesses

Computing after-tax income for businesses is relatively the same as for individuals. However, instead of determining gross income, enterprises begin by defining total revenues. Business expenses, as recorded on the income statement, are subtracted from total revenues producing the firm’s income. Finally, any other relevant deductions are subtracted to arrive at taxable income.

The difference between the total revenues and the business expenses and deductions is the taxable income, on which taxes will be due. The difference between the business’s income and the income tax due is the after-tax income.

After-Tax and Pretax Retirement Contributions

The terms after-tax and pretax income often refer to retirement contributions or other benefits. For example, if someone makes pretax contributions to a retirement account, those contributions are subtracted from their gross pay. After deductions are made to the gross salary amount, the employer will calculate payroll taxes.

Medicare contributions and Social Security payments are calculated on the difference after these deductions are taken from the gross salary amount. However, if the employee makes after-tax contributions to a retirement account, the employer applies taxes to the employee’s gross pay and then subtracts the retirement contributions from that amount.

What Is Accrued Income?

Accrued income is the money a company has earned in the ordinary course of business but has yet to be received, and for which the invoice is yet to be billed to the customer.

Mutual funds or other pooled assets that accumulate income over a period of time—but only pay shareholders once a year—are, by definition, accruing their income. Individual companies can also generate income without actually receiving it, which is the basis of the accrual accounting system.

Understanding Accrued Income

Most companies use accrual accounting. It is an alternative to the cash accounting method and is necessary for companies that sell products or provide services to customers on credit. Under the U.S. generally accepted accounting principles (GAAP), accrual accounting is based on the revenue recognition principle. This principle seeks to match revenues to the period in which they were earned, rather than the period in which cash is received.

In other words, just because money has not yet been received, it does not mean that revenue has not been earned.

The matching principle also requires that revenue be recognized in the same period as the expenses that were incurred in earning that revenue. Also referred to as accrued revenue, accrued income is often used in the service industry or in cases in which customers are charged an hourly rate for work that has been completed but will be billed in a future accounting period. Accrued income is listed in the asset section of the balance sheet because it represents a future benefit to the company in the form of a future cash payout.

In 2014, the Financial Accounting Standards Board, which establishes regulations for U.S. businesses and non-profits, introduced “Accounting Standards Code Topic 606 Revenue from Contracts with Customers” to provide an industry-neutral revenue recognition model to increase financial statement comparability across companies and industries. Public companies were required to apply the new revenue recognition rules beginning in Q1 2018. The FASB also issued the following amendments to ASU No. 2014-09 to provide clarification on the guidance:

-ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606) – Deferral of the Effective Date

-ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606) – Principal versus Agent Considerations (Reporting Revenue Gross Versus Net)

-ASU No. 2016-10, Revenue from Contracts with Customers(Topic 606) – Identifying Performance Obligations and Licensing

-ASU No. 2016-12, Revenue from Contracts with Customers (Topic 606) – Narrow-Scope Improvements and Practical Expedients 

Examples of Accrued Income

Assume Company A picks up trash for local communities and bills its customers $300 at the end of every six-month cycle. Even though Company A does not receive payment for six months, the company still records a $50 debit to accrued income and a $50 credit to revenue each month. The bill has not been sent out, but the work has been performed, and therefore expenses have already been incurred and revenue earned.

When cash is received for the service at the end of six months, a $300 credit in the amount of the full payment is made to accrued income, and a $300 debit is made to cash. The balance in accrued income returns to zero for that customer.

Accrued income also applies to individuals and their paychecks. The income that a worker earns usually accrues over a period of time. For example, many salaried employees are paid by their company every two weeks; they do not get paid at the end of each workday. At the end of the pay cycle, the employee is paid and the accrued amount returns to zero. If they leave the company, they still have pay that has been earned but has not yet been disbursed.