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How to Annualize Your Income to Pay Estimated Taxes

With the annualization method, taxpayers can pay more tax at the times when they are earning more money, and less tax when their receipts are down or their expenses are up. To annualize your income to pay estimated taxes you have to monitor your income and expenses during the year and base your estimated payments on actual income rather than on estimates.

This method is particularly useful for people whose income fluctuates during the year. Here are some examples of people who can really benefit from the annualization method of determining estimated payments.

  • Seasonal workers

  • People who change jobs during the year

  • Self-employed people who don’t have a lot of control over when their income is received

  • People who incur a sizeable deductible expense during the year

The goal when annualizing your income is to determine what your full year’s earnings would be if you continued to earn at the same pace at which you have earned income thus far during the year. To annualize your income for a particular estimated payment, you should follow these steps:

  1. Figure out your actual income for all the months of the year prior to the month in which the quarterly payment is due.

  2. Divide the amount from the previous step by the number of months represented, and then multiply that amount by 12.

    This gives you the amount of total income you would earn if everything stayed the same for the rest of the year.

    Perform Steps 1 and 2 on your itemized deductions so that you have an estimate of the total amount of your itemized deductions for the entire year.

  3. Compare your itemized deductions that you calculated in the previous step to the Standard Deduction

    Take the greater amount and deduct that amount from your income that you calculated in step 2.

  4. Deduct your exemptions from the amount calculated in the previous step.

    Exemptions for 2008 are expected to be $3,400 a head, which means that you’re going to deduct $3,400 for yourself, another $3,400 if you have a spouse and file a joint tax return, and another $3,400 for each of your dependents. The result is your annualized taxable income.

  5. Figure out the tax on the taxable income computed in.

    Use tax tables from online.

  6. Multiply the tax you calculated by 90 percent, and then divide by four.

    This is the amount you should pay in estimated tax for the current quarter.

You’ll be so grateful if you use Quicken when it comes to trying to annualize your income. All of those itemized deductions, income from a variety of sources — it’s all right there, just a Tax Summary report away.

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