Loading the player...

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.

BREAKING DOWN '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.

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. 

RELATED TERMS
  1. Tax Benefit

    A tax benefit is an allowable deduction on a tax return intended ...
  2. Tax Relief

    Tax relief is any program or incentive that reduces the amount ...
  3. Taxes

    An involuntary fee levied on corporations or individuals that ...
  4. Income Tax

    A tax that governments impose on financial income generated by ...
  5. Direct Tax

    A direct tax is a tax paid directly by an individual or organization. ...
  6. Liability

    A liability is defined as a company's legal financial debts or ...
Related Articles
  1. Taxes

    What's IRS Form 1040 For?

    Most U.S. taxpayers will be familiar with the 1040. By the end of filling it out, you'll know how much tax you owe, or what your refund is.
  2. Taxes

    Deferred Tax Liability

    Deferred tax liability is a tax that has been assessed or is due for the current period, but has not yet been paid. The deferral arises because of timing differences between the accrual of the ...
  3. Financial Advisor

    3 Federal Income Tax Facts You Didn't Know

    Learn about three federal income tax facts that most Americans may not know from one of the most trusted financial resources on the Web.
  4. Taxes

    How to Owe Nothing on Your Federal Tax Return

    You have the control to determine whether you owe in April. Learn how to owe nothing on your federal tax return.
  5. Taxes

    Investment Tax Basics For All Investors

    Nothing can be said to be certain, except death and taxes even in your investments.
  6. Taxes

    Tax Withholding: Good For Government, Bad For Taxpayers

    It's important to understand where that money coming out of your paycheck goes and why - after all, you earned it.
  7. Insights

    A Concise History Of Changes In U.S. Tax Law

    We look at how U.S. taxes have changed since their inception.
  8. Taxes

    How Tax Cuts Stimulate the Economy

    Learn the logic behind the belief that reducing government income benefits everyone.
  9. Taxes

    How Getting A Raise Affects Your Taxes

    Many people think they may actually make less overall because they are paying more taxes.
RELATED FAQS
  1. How does the marginal tax rate system work?

    The marginal tax rate is the rate of tax that income earners incur on each additional dollar of income. Read Answer >>
Hot Definitions
  1. Intrinsic Value

    Intrinsic value is the perceived or calculated value of a company, including tangible and intangible factors, and may differ ...
  2. Current Assets

    Current assets is a balance sheet account that represents the value of all assets that can reasonably expected to be converted ...
  3. Volatility

    Volatility measures how much the price of a security, derivative, or index fluctuates.
  4. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
  5. Cost of Debt

    Cost of debt is the effective rate that a company pays on its current debt as part of its capital structure.
  6. Depreciation

    Depreciation is an accounting method of allocating the cost of a tangible asset over its useful life and is used to account ...
Trading Center