The income must be recognized in the year received, so the tax will be due in one lump sum by April 15th of the following year. As stated, income averaging applies only to very specific cases nowadays.
The tax being due April 15th doesn’t mean you absolutely have to pay it then, just that interest starts accumulating. You can extend filing and paying 6 months, and you can also set up a payment plan that can stretch it out over many years.
For what it’s worth, this kind of scenario is pretty common among people who own investments like rental property and stock. When the appreciated property is sold, you can see gains of millions or even billions in a single year. (Just think about that the next time you hear about some dot-com selling for a ridiculous price).
My understanding has been that income tax is not due on April 15, it’s due when you actually earn the money, and that:
-this is why income tax is normally deducted from every paycheck you receive;
-if you find that over the course of a tax year you’ve underpaid by more than a couple thousand dollars (i.e. you’re sending in a huge check on April 15 along with your completed tax return), you end up owing interest, and possibly a penalty; and
-For people who do not typically have taxes deducted from their paychecks, they are supposed to make quarterly estimated tax payments to the IRS, otherwise they could be hit with the aforementioned interest/penalty.
So income tax would be owed when that $100,000 is received, whether it’s received as a lump sum or as a steady stream of payments over the tax year.
All true - however if you can demonstrate that you had enough taxes withheld to cover the prior year’s tax bill (or 90% of it or something like that - I think the percentages vary by income level), you can avoid the penalty. That covers the windfall / sudden increase in income situation pretty well.
Of course, you still owe the taxes, just not the penalty.
And yes, you can pay it via an installment agreement. Also, depending on the nature of the income, you might have taxes withheld from that at the time it’s given - e.g. I get a bonus every March. It’s taxed at the time it’s paid out.
Whoops, forgot about that trick. You’re right, and I’ve used that guideline to adjust my paycheck witholding rate so that when I file my return, I send in a small check (instead of receiving a large refund).
I would think that it would be simpler to just set aside your anticipated tax burden immediately, and consider it not a $100K windfall, but a $65K windfall (or whatever). Uncle Sam’s gonna get his no matter what, why not just be done with it sooner?
Only the most arrogant (or supremely skilled/lucky…) investor would imagine himself being able to earn more with the extra money not yet paid in taxes (in the alloted timeframe) than the interest/penalties would be.