Annualized Income Installment Method: Schedule AI and Worked Example

The annualized income installment method lets you size each quarterly estimated tax payment to the income you actually earned by that point in the year, instead of paying a flat 25% of your projected annual tax four times. It’s built into Section 6654 of the Internal Revenue Code and is the route out of an underpayment penalty for consultants, seasonal business owners, and investors whose earnings cluster in one or two quarters rather than spreading evenly across all four.¹ You claim it by filling out Schedule AI of Form 2210 and attaching it to your return.

Check First Whether You Need It

The annualized method is worth the effort only if you’d otherwise owe a penalty. The IRS won’t charge one when the gap between your total tax and what you’ve already paid through withholding is under $1,000. You’re also exempt if you had zero tax liability the prior year, as long as that year was a full 12 months and you were a U.S. citizen or resident throughout.¹

Beyond those, there are two standard safe harbors. You’re covered if your withholding plus estimated payments equal at least the lesser of 90% of the current year’s tax or 100% of last year’s tax.¹ If your prior-year adjusted gross income was over $150,000 (or $75,000 married filing separately), the prior-year benchmark rises to 110%.² If you can hit either safe harbor with four equal payments, the annualized method is unnecessary. It earns its keep when equal payments would force you to send tax on money you hadn’t yet received.

How the Calculation Works

The method replaces the flat-quarter assumption with a projection tied to your actual cumulative income at four measurement points. For each period, you take your income through that date, multiply by an annualization factor to project a full-year figure, calculate the tax on that projection, then apply an “applicable percentage” to determine how much should have been paid by that installment’s deadline.

The four measurement windows end March 31, May 31, August 31, and December 31, and each is cumulative. The multipliers are 4, 2.4, 1.5, and 1.0 respectively, since the periods cover 3, 5, 8, and 12 months. The applicable percentages are 22.5% for the first installment, 45% for the second, 67.5% for the third, and 90% for the fourth.¹³ After you calculate the cumulative required payment for a period, you subtract what you already paid in earlier periods to get the net amount due.

Any reduction you get in an earlier installment gets picked up in a later one. You’re not paying less tax overall, just moving each installment to reflect when the income actually arrived.¹

Payment Deadlines vs. Measurement Periods

The 2026 estimated tax payment deadlines are April 15, June 15, September 15, and January 15, 2027.⁴ The measurement windows on Schedule AI don’t line up with them. The first payment, due April 15, is based on income through March 31. The second, due June 15, is based on income through May 31.⁵ Confusing the two sets of dates and using the wrong income totals will produce wrong numbers and can leave a penalty in place that you thought you’d eliminated.

A Worked Example

Say you’re a consultant who has taken in $15,000 by March 31. Multiplied by 4, that projects to $60,000 for the year. You calculate the tax on $60,000 of income, take 22.5%, and that’s your first required installment.

If you then have $40,000 cumulative through May 31, the multiplier of 2.4 projects $96,000 for the year. Calculate the tax on $96,000, take 45%, then subtract what you already paid for the first period. The remainder is your second installment. You repeat the pattern for the August 31 cutoff (multiplier 1.5, applicable percentage 67.5%) and again for December 31 (multiplier 1.0, applicable percentage 90%).

Self-Employment Tax, Credits, and Deductions

Self-employed filers have to annualize self-employment income for each period in parallel with regular income. The statute expressly requires this, and Schedule AI has dedicated lines that apply the same multipliers to compute Social Security and Medicare tax on the projected earnings.¹

Deductions get allocated to the period they were actually paid, then annualized alongside income. For credits, any income or deduction figure that feeds the credit calculation has to be annualized too. If earned income through March 31 is $8,000, for example, you’d run the earned income credit off annualized earned income of $32,000 for that first period.⁵

Records You Need

Ordinary annual totals aren’t enough. This method needs to know exactly when each dollar of income arrived and when each deductible expense was paid, organized around the March 31, May 31, August 31, and December 31 cutoffs. Bank statements, invoices, brokerage statements, and receipts should all be sortable by those dates.

Watch the timing rules. A capital gain from a stock sale belongs on the trade date, not the settlement date. A consulting payment counts when you received it, not when you sent the invoice, assuming you’re on the cash method (as most individual taxpayers are). One large receipt landing in the wrong period can distort your projected annual income and throw off the whole calculation. A running ledger keyed to the four cutoff dates is the easiest way to avoid that.

Filing Schedule AI With Your Return

To actually claim the benefit, attach Form 2210 (Parts I, II, and III) together with Schedule AI to your Form 1040.⁵ Most tax software prompts for the form when it spots a possible underpayment. On a paper return, place the form directly after your 1040 so it’s processed with it. If you file without Schedule AI while relying on the annualized method, the IRS’s automated system will default to the equal-payment assumption and generate a penalty notice.

If You Still Fall Short

The underpayment penalty is essentially interest on each installment’s shortfall, running from that installment’s due date until it’s paid or the return deadline arrives. The rate can shift quarterly. For the first quarter of 2026 the rate was 7% per year, compounded daily,⁶ and it dropped to 6% starting in the second quarter.⁷

Reasonable cause alone won’t get the underpayment penalty waived. The IRS can remove or reduce it when the shortfall came from a casualty, a local disaster, or another unusual circumstance where charging it would be unfair; the request goes in writing, signed under penalty of perjury, to the address on your notice.² A separate waiver is available if you retired after reaching age 62 or became disabled during the tax year or the year before, and the underpayment was due to reasonable cause rather than neglect.⁸

1
Office of the Law Revision Counsel. 26 USC 6654 – Failure by Individual to Pay Estimated Income Tax
2
Internal Revenue Service. Underpayment of Estimated Tax by Individuals Penalty
3
Internal Revenue Service. Form 2210 – Underpayment of Estimated Tax by Individuals, Estates, and Trusts
4
Taxpayer Advocate Service. Your Tax To-Do List – Important Tax Dates
5
Internal Revenue Service. Instructions for Form 2210
6
Internal Revenue Service. Interest Rates Remain the Same for the First Quarter of 2026
7
Internal Revenue Service. Internal Revenue Bulletin 2026-8
8
Internal Revenue Service. Topic No. 306 – Penalty for Underpayment of Estimated Tax