What Is a Tax Liability?
A tax liability is the total amount of tax debt owed by an individual, corporation or other entity to a taxing authority like the Internal Revenue Service (IRS). It is the total amount of tax you're responsible for paying to the taxman. Tax liabilities are incurred due to earning income, a gain on the sale of an asset or other taxable events. No tax liability means the taxpayer's total tax liability was zero in the prior year, or they did not have to file a tax return.
Understanding Tax Liability
A tax liability is the amount of taxation that a business or an individual incurs based on current tax laws. Taxes are imposed by a variety of taxing authorities, including federal, state and local governments. When a taxable event occurs, the taxpayer needs to know the tax base for the event and the rate of tax on the tax base.
The tax liability doesn't just include the current year, instead, it factors in any and all years that the entity may owe taxes. That means that if there are back taxes (any taxes that remain unpaid from previous years) due, those are added to the tax liability as well.
Examples of Income Tax Liability
The most common type of tax liability for taxpayers is the tax on earned income. Assume, for example, that a taxpayer earns $50,000 in gross income, which is reported on an IRS W-2 form at the end of the year. If the federal tax rate is 20 percent, the tax base of $50,000 is multiplied by the 20 percent rate to compute a federal tax liability of $10,000.
Assume that the taxpayer’s W-4 resulted in the employer withholding $8,000 in federal taxes and that the taxpayer made a $1,000 tax payment during the year. When the taxpayer files the Form 1040 individual tax return, the remaining tax payment due is the $10,000 tax liability less the $9,000 in withholdings and payments, or $1,000. On the other hand, if the taxpayer's W-4 information resulted in $5,000 in withholdings and no $1,000 tax payment is made during the year, the tax payment due with the tax return is the $10,000 liability less the $5,000 payment, or $5,000.
Tax liability includes all years that the entity may owe taxes.
How Capital Gains Are Taxed
When a taxpayer sells an investment, real estate or another asset for a gain, that individual pays taxes on the gain. Assume, for example, that a taxpayer purchases 100 shares of XYZ common stock for $10,000 and sells the securities five years later for $18,000. The $8,000 gain is considered to be the tax base for this taxable event, and the transaction is a long-term capital gain since the holding period is greater than one year. The tax rate for capital gains can be different from rates for income taxes and other tax calculations. If the tax rate is 10 percent, the tax liability is $800 and the taxpayer will include this calculation on the individual 1040 tax return.
Line 63 — Total Tax (Liability)
Filled out your Form 1040? Lines 52 through 62 added together will give you your total tax liability to the IRS—and that total will go into line 63. This appears on the last page of the Form 1040. Sometimes that sum might make your stomach turn because it can appear high. Not to fret. When the tax liability is calculated, you will then adjust the liability for estimated tax payments, tax credits, and other items to compute the amount of taxes currently due and unpaid. If you overpaid, then you end up with a refund. On the other hand, if you paid too little, then you'll owe the IRS some more change.