Tax Liability: Definition, Calculation, and Example

What Is Tax Liability?

Tax liability is the payment owed by an individual, business, or other entity to a federal, state, or local tax authority.

Generally, you have a tax liability when you earn income or generate profits by selling an investment or other asset. It is possible to have no income tax liability if you don't meet the income requirements to file taxes.

Key Takeaways

  • Tax liability is the total amount of tax debt owed to a government by an individual, corporation, or other entity.
  • Income taxes, sales tax, and capital gains tax are all forms of tax liabilities.
  • Taxes are imposed by various taxing authorities, including federal, state, and local governments. Taxes generate the funds to pay for services such as repairing roads and maintaining a military.
  • You can lower your tax liabilities by claiming deductions, exemptions, and tax credits.
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Tax Liability

Understanding Tax Liability

Various authorities, including federal, state, and local governments, impose taxes and use the funds to pay for services such as repairing roads, funding social programs, and maintaining a military.

Companies withhold income, Social Security, and Medicare taxes from employees' wages and send them to the federal government.

It's important to note that your tax liability doesn't just include the current year. Instead, it factors in any years for which taxes are owed. That means that if back taxes (any unpaid taxes from previous years) are due, those are also added to your tax liability.

How to Calculate Your Tax Liability

The most common tax liability for Americans is the tax on earned income. For federal taxes, you use the tax brackets and standard deductions issued by the Internal Revenue Service.

Standard deductions for 2022 are:

  • $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

Standard deductions for 2023 are:

  • $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
2022 Tax Brackets
Tax Rate Single Filer in 2022   Married Filing Separately in 2022 Married Filing Jointly in 2022 Head of Household in 2022
10% $10,275 or less $10,275 or less $20,550 or less $14,650 or less
12%  Over $10,275 Over $10,275 Over $20,550 Over $14,650
22%  Over $41,775 Over $41,775 Over $83,550 Over $55,900
24%  Over $89,075  Over $89,075 Over $178,150 Over $89,050
32%  Over $170,050 Over $170,050 Over $340,100 Over $170,050
35%  Over $215,950 Over $215,950 Over $431,900 Over $215,950
37%  Over $539,900 Over $323,925  Over $647,850 Over $539,900
2023 Tax Brackets
Tax Rate Single Filer in 2023   Married Filing Separately in 2023 Married Filing Jointly in 2023 Head of Household in 2023
10% $11,000 or less $11,000 or less $22,000 or less $15,700 or less
12%  Over $11,000 Over $11,000 Over $22,000 Over $15,700
22%  Over $44,725 Over $44,725 Over $89,450 Over $59,850
24%  Over $95,375  Over $95,375 Over $190,750 Over $95,350
32%  Over $182,100 Over $182,100 Over $364,200 Over $182,100
35%  Over $231,250 Over $231,250 Over $462,500 Over $231,250
37%  Over $578,125 Over $346,875  Over $693,750 Over $578,100

Imagine you're a single filer in 2022, earning $72,950 per year. After applying your standard deduction of $12,950, your reportable income is $60,000. You also have no other deductions or income. Because your adjusted gross income is between $41,775 and $89,075, you fall into the 22% tax bracket. Your tax liability is computed for each tax bracket up to the one you're in. Here's how it works:

  • Your first $10,275 is taxed at 10%, so you owe $10,275 x 10% = $1,028
  • The amount over $10,275 but under $41,775 is taxed at 12%, so you owe $31,500 x 12% = $3,780
  • The amount over $41,775 but under $89,075 is taxed at 22%, so you owe $18,225 x 22% = $4,010
  • You total up each amount you owe per bracket $1,028 + $3,780 + $4,010 = $8,818
  • Your total tax liability is $8,818 plus back taxes, if any

Liability or Refund?

Now assume that your W-4 resulted in your employer withholding $7,500 in federal taxes. When you file your individual tax return (Form 1040), you haven't met your tax liability so you owe taxes. In this case, you'd owe $8,818 - $7,500 = $1,318.

If your W-4 resulted in your employer withholding $9,200 in federal taxes, the IRS would refund you $9,200 - $8,818 = $382.

To calculate your state tax liability, locate your state's standard deductions and tax information and use the instructions provided by the state. Some states have a single tax rate, and others have graduated brackets.

How Capital Gains Are Taxed

When you sell an investment, real estate, or any other asset for a gain, you owe taxes on the gain. If you sell it for a loss, you can report it as a capital loss. Capital gains are taxed in two different ways: long-term capital gain and short-term capital gain. If you've held an asset for one year or less and sold it for a gain, it is a short-term capital gain included in your income.

If you hold an asset for more than one year and sell it for a gain, it is considered a long-term capital gain and is subject to the capital gains tax. There are capital gains thresholds, similar to income tax brackets.

2022 Capital Gains Tax
Capital Gains Tax Rate Single Filer Taxable Income Married Filing Separate Taxable Income  Head of Household Taxable Income Married Filing Jointly Taxable Income
0% $41,675 or less $41,675 or less $55,800 or less $83,350 or less
15%  $41,676 to $459,750 $41,676 to $258,600 $55,801 to $488,500 $83,351 to $517,200
20%  $459,751 or more $258,601 or more  $488,501 or more $517,201 or more
2023 Capital Gains Tax
Capital Gains Tax Rate Single Filer Taxable Income Married Filing Separate Taxable Income  Head of Household Taxable Income Married Filing Jointly Taxable Income
0% $44,625 or less $44,625 or less $59,750 or less $89,250 or less
15%  $44,626 to $492,300 $44,626 to $276,900 $59,751 to $523,050 $89,251 to $553,850
20%  $492,301 or more $276,901 or more  $523,051 or more $553,851 or more

Here is how it works: assume you purchase 100 shares of XYZ common stock for $10,000 in 2022 and sell them five years later for $18,000. The $8,000 gain is a taxable event. Because you held the stock for more than one year, the gain is a long-term capital gain.

Using the previous example, if your adjusted gross income was $60,000, your capital gains bracket is 15%. So, you'd need to pay 15% of $8,000 in taxes, or $1,200. If you had held the stocks for less than one year, you'd include the $8,000 in your gross income before subtracting your standard deduction.

So, if you earned $72,950 and had $8,000 in short-term capital gains, your total income is $80,950. If your filing status and other deductions were the same as in the previous example, you'd still be in the 22% tax bracket and would work through the calculations the same way with the new income amount.

How to Reduce Your Tax Liability

Taxes can take a significant bite out of your take-home pay, but it's something everyone has to live with to fund the government programs we rely on; however, there are a few ways to reduce the amount of taxes you pay.

Deductions and Credits

You might qualify for other deductions or credits. Deductions reduce your taxable income, and credits reduce the amount of tax you owe. Some deductions you might be able to take are:

  • Business expenses
  • Using your car for business purposes
  • Using your home for business purposes
  • Itemized deductions
  • Education deductions
  • Healthcare deductions
  • Investment deductions

Some credits are:

  • Family and dependent credits
  • Income and savings credits
  • Homeowner credits
  • Healthcare credits
  • Education credits

Contribute to a Retirement Fund

Contributing to a retirement fund does more than help you save for and grow your retirement nest egg—if carefully planned, you can reduce your tax liability for years to come. You can contribute a specific amount per year to your IRA, which is tax-deferred. You contribute to a Roth IRA after you've paid taxes.

To lower your tax liability by contributing, you'll only need to determine how much you plan to be taxed in retirement by projecting your income and withdrawals. If you're in a higher tax bracket now than you will be in retirement, a traditional IRA can lower your total tax payments because:

  • Taxes are deferred
  • You'll be in a lower bracket with less tax liability later

If you're sure you'll be in a higher tax bracket after you retire and begin taking withdrawals, a Roth IRA can lower your total tax payments because withdrawals are tax-free.

How Is Tax Liability Determined?

You determine your tax liability by subtracting your standard deduction from your taxable income and referring to the appropriate IRS tax brackets.

How Do I Know If I Have No Tax Liability?

You have no tax liability if you aren't required to file income taxes or have no taxable income for the tax year.

How Do I Reduce My Tax Liability?

Some ways to reduce your tax liability include contributing to a retirement or health savings account. You can also use credits or other deductions to reduce your taxable income.

The Bottom Line

Tax liability is the amount of taxes you owe on your taxable income for the year. If you earn income, you'll have a tax liability.

To determine your tax liability, you add all your income and subtract your standard deduction to figure out your taxable income. Then, refer to the IRS tax brackets to find your tax liability.

Article Sources
Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy.
  1. Internal Revenue Service. "IRS Provides Tax Inflation Adjustments for Tax Year 2022."

  2. Internal Revenue Service. "IRS Provides Tax Inflation Adjustments for Tax Year 2023."

  3. Tax Foundation. "State Individual Income Tax Rates and Brackets for 2022."

  4. Internal Revenue Service. "Topic No. 409 Capital Gains and Losses."

  5. Internal Revenue Service. "Credits and Deductions for Individuals."

  6. Internal Revenue Service. "Traditional and Roth IRAs."

  7. Internal Revenue Service. "Tax Withholding Estimator."

  8. Internal Revenue Service. "More in Help."

  9. Internal Revenue Service. "IRS Provides Tax Inflation Adjustments for Tax Year 2023."

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