What Is Tax Liability?
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). In other words, it is the total amount of tax you're responsible for paying to the taxman. Tax liabilities are incurred when income is earned, when there is a gain on the sale of an asset, or when another taxable event occurs. No tax liability means a taxpayer's total tax was zero in the prior year, or they did not have to file a tax return.
- Tax liability is the total amount of tax debt owed by an individual, corporation, or other entity to a taxing authority, such as the IRS.
- Income taxes, sales tax, and capital gains tax are all forms of tax liabilities.
- Taxes are imposed by a variety of taxing authorities, including federal, state, and local governments, which use the funds to pay for services such as repairing roads and defending the country.
- Both individuals and corporations can lower their tax liabilities by claiming deductions, exemptions, and tax credits.
Understanding Tax Liability
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, which use the funds to pay for services such as repairing roads and defending the country. 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.
Sales tax and company payrolls are forms of tax liability. When businesses sell their products, most state and local governments charge a sales tax, which is a percentage of each sale and is paid by customers. Businesses send sales taxes to taxing authorities monthly or quarterly. Companies withhold income taxes and taxes for Social Security and Medicare from employees' wages.
An individual's or corporation's tax liability doesn't just include the current year; instead, it factors in any and all years for which taxes are owed. 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 Tax Liability
The most common type of tax liability for taxpayers is the tax on earned income. Assume, for example, that Anne earns $60,000 in gross income, which is reported on an IRS W-2 form at the end of the year. With a federal tax rate of 22% for that level of income, Anne's tax liability would be $8,990 based on 2020 tax brackets. In particular, Anne would owe 10% on the first would owe 10% on the first $9,875 of income, 12% on the next $30,250, and 22% on the last $19,875.
Assume that Anne's W-4 resulted in her employer withholding $6,500 in federal taxes and that she made a $1,000 tax payment during the year. When Anne files Form 1040, her individual tax return, the remaining tax payment due is the $8,990 tax liability less the $6,500 in withholdings and $1,000 payments, or $1,490.
Tax liability includes all years that an individual, corporation, or other 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%, the tax liability is $800 and the taxpayer will include this calculation on their individual 1040 tax return.
Special Considerations: Line 16
Filled out your Form 1040? Line 16, which appears on page two of Form 1040, is your total tax liability to the IRS. Sometimes that sum might make your stomach turn because it can appear high. However, when your tax liability is calculated, you adjust it for federal income tax withheld, deductions, exemptions, and tax credits in order to compute the amount of taxes currently due and unpaid. If you overpaid, you end up with a refund. On the other hand, if you paid too little, you'll owe the IRS some more.