Tax liability encompasses income tax, direct taxes, and indirect taxes imposed by the government. It applies to various entities, including individuals, corporations, partnerships, LLPs, LLCs, etc.
This liability can be projected as an approximation of the annual tax obligations, divided into quarterly advance tax payments. The remaining tax liability on income is settled upon filing the annual income tax return. In this article, we will elaborate on the same in-depth while answering what a tax liability is. Also, check out Beem for the best tax filing assistance experience across all filing statuses and tax forms.
What is Tax Liability?
Tax liability is a legal obligation governed by a country’s tax laws, applicable to both residents and non-residents. This tax utilizes funds for essential purposes like road repairs, sustaining military operations, and supporting social programs. Various income sources, such as business, capital gains, profession, salary, and other avenues, contribute to tax liability.
How to Calculate Your Tax Liability?
The primary tax obligation for Americans is the tax on earned income, calculated using the tax brackets and standard deductions provided by the Internal Revenue Service (IRS).
For 2022, the standard deductions are as follows:
- $12,950 for single filers
- $12,950 for married couples filing separately
- $19,400 for heads of households
- $25,900 for married couples filing jointly
And for 2023:
- $13,850 for single filers
- $13,850 for married couples filing separately
- $20,800 for heads of households
- $27,700 for married couples filing jointly
Tax rates vary based on income levels, with different brackets for single filers, married couples filing separately, married couples filing jointly, and heads of households.
Let’s break it down with an example: In 2022, if you’re a single filer earning $72,950, after applying the $12,950 standard deduction, your taxable income is $60,000. With no other deductions or income, falling into the 22% tax bracket means your tax liability is calculated as follows:
The first $10,275 is taxed at 10%, resulting in $1,028 owed.
The amount between $10,275 and $41,775 is taxed at 12%, leading to $3,780 owed.
The portion between $41,775 and $89,075 is taxed at 22%, resulting in $4,010 owed.
Adding these amounts together gives a total tax liability of $8,818, not including any back taxes if applicable.
Why It’s Important to Know Your Tax Liability
Knowing your tax liability is crucial for several reasons:
1. Financial Planning: Understanding tax liability facilitates effective financial planning, ensuring budget alignment for timely tax payments and preventing last-minute financial strain.
2. Avoiding Penalties: Awareness of tax obligations helps meet payment deadlines, preventing penalties and interest charges, thereby maintaining good standing with tax authorities.
3. Optimizing Withholdings: Adjusting your W-4 or equivalent forms and knowing tax liability aids in adjusting withholdings, optimizing paycheck deductions to prevent overpayment, and allowing for better cash flow throughout the year.
4. Strategic Financial Decision-Making: Tax implications influence strategic decisions in investments, business expenses, and retirement planning, aligning choices with long-term financial goals.
5. Minimizing Unexpected Financial Burdens: Regular assessment of tax situations helps adapt to income changes, minimizing the risk of unforeseen tax burdens and preserving financial resources.
6. Compliance with Tax Laws: Understanding tax liability ensures compliance with tax laws, preventing unintentional non-compliance and legal consequences while fulfilling taxpayer responsibilities.
Examples of Income Tax Liability
Income tax liability arises whenever there’s a taxable event, such as earning income or selling assets. The most common form is earned income, categorized into brackets with corresponding tax rates.
For the tax year 2022, the following rates and brackets apply:
| Tax Rate | Single Filer | Married, Filing Jointly | Head of Household | Married, filing Separately |
| 10% | $0–10,275 | $0–20,550 | $0–14,650 | $0–10,275 |
| 12% | $10,276–41,775 | $20,551–83,550 | $14,651–55,990 | $10,276–41,775 |
| 22% | $41,776–89,075 | $83,551–178,150 | $55,991–89,050 | $41,776–89,075 |
| 24% | $89,076–170,050 | $178,151–340,100 | $89,051–170,050 | $89,076–170,050 |
| 32% | $170,051–215,950 | $340,101–431,900 | $170,051–215,950 | $170,051–215,950 |
| 35% | $215,951–539,900 | $431,901–647,850 | $215,951–539,900 | $215,951–323,925 |
| 37% | Over $539,900 | Over $647,850 | Over $539,900 | Over $323,925 |
For example, if you earn $60,000 annually as a single filer and take the $12,950 standard deduction, your taxable income is $47,050, placing you in the 22% tax bracket. However, you don’t pay 22% on the entire amount; each portion is taxed at the respective rates.
For instance:
The first $10,275 is taxed at 10% ($1,027.50).
The next portion, $10,276 to $41,775, is taxed 12% ($3,780).
The remainder, over $41,775, is taxed at 22% ($1,160.50).
The total tax liability for this scenario is $5,968. While this is a simplified example, additional factors like tax credits and deductions can influence your overall tax situation.
How to Reduce Your Tax Liability?
Maximizing tax benefits involves leveraging deductions and credits to reduce tax liability. Deductions, like the standard or itemized deductions for expenses such as medical costs and mortgage interest, lower your taxable income. Opt for the standard deduction if it exceeds your itemized deductions, especially since it was nearly doubled in 2017.
Tax credits, distinct from deductions, directly decrease your total tax bill post-application of tax percentages. Examples include child or dependent tax credits and the adoption credit. To further slash tax liability, contribute to a 401(k) or pre-tax retirement account, lowering taxable income. However, weigh this against potential taxes upon retirement age. However, take your time with clearing the debt and establishing a robust emergency fund.
How is Tax Liability Determined?
Calculating your tax liability involves deducting the standard deduction from your taxable income and consulting the relevant IRS tax brackets. This process helps determine the portion of your income subject to taxation.
How to Find Your Tax Liability on the 1040 Form?
To find your tax liability on the 1040 form, subtract your applicable deductions from your taxable income and reference the IRS tax tables to determine the owed amount.
What is Your Small Business Tax Liability?
Determining your small business tax liability involves understanding various taxable events that trigger obligations:
Business Tax Liability
Businesses must pay taxes on profits. Business taxes pass through to owners through structures like sole proprietorships, partnerships, S corporations, or LLCs. As separate entities, C corporations face corporate income tax rates (21% federally) and potential state corporate taxes.
Self-Employment Tax Liability
Self-employed individuals, excluding incorporated businesses, pay Social Security and Medicare taxes through self-employment tax. This liability covers employer and employee portions and amounts to 15.3% of net earnings.
Payroll Tax Liability
The employer is responsible for withholding and remitting payroll taxes. This includes federal and state income taxes, FICA taxes, and contributions for unemployment taxes. Payroll tax liability encompasses both employee withholdings and employer contributions.
Earned Income Tax Liability
Individuals typically pay federal, state, and local income taxes on their earnings. Small business owners who do not receive traditional wages may need to make estimated tax payments to cover earned income tax liability.
Capital Gains Tax Liability
Selling investments or assets for a profit may trigger capital gains tax. This tax applies to the gain, calculated as the selling price minus the purchase price.
Sales Tax Liability
Selling goods requires adding sales tax, creating a sales tax liability. Collected taxes must be remitted to the state or local government. Rates vary based on business location.
Property Tax Liability
Business-owned real estate incurs property tax liability. Rates are determined by property value and vary by location. Local governments reassess rates annually.
Conclusion
Tax liability is the amount of taxes an individual owes to the government on their taxable income in a year. Any individual who earns an income is liable to pay taxes. As a taxpayer, you can determine your tax liability on your taxable income by adding all the income from different sources and subtracting the standard deduction. You will have no tax liability toward the government if you have not earned an income during the year. Beem will help you file your federal and state taxes online at the best prices .
FAQs
Who is liable to pay income tax?
Individuals and entities with taxable income are liable to pay income tax. This includes individuals earning income, businesses, and other entities with taxable profits.
How is tax liability recorded?
Tax liability is recorded as a provision on the financial statements of individuals or businesses. This provision represents the estimated amount of income tax owed for a specific period and is adjusted based on income or tax law changes.
Is tax a liability or expense?
Tax is both a liability and an expense. It becomes a liability when taxes are incurred but have yet to be paid, and it’s recorded as an expense when paid. The tax liability represents the amount owed, while the tax expense reflects the actual payment made.
Is income tax paid a liability?
Yes, income tax paid is considered a liability when the tax obligation exists but has not been settled. Once the payment is made, it transitions from a liability to an expense on the financial statements.
