What is Tax Liability?

If you pay taxes, you’ve definitely asked yourself this question at some point. We don’t want to fill you in on the details and explanations of accounting jargon. However, to understand tax liability, you must first familiarize yourself with assets and liabilities.

A Tax Account in Los Angeles describes assets as things you own, such as property, money, or a collection of limited-edition action figures. Liabilities, on the other hand, point to the money you owe to third parties. Here’s an example: your electricity bill is a liability.

So, what is tax liability? It’s the tax bill you owe to the federal, state, or local government body. Usually, most people refer to federal taxes when talking about tax liability.

Total tax liability

The total tax liability is the combined sum of money you pay the IRS in the form of capital gains tax, self-employment tax, income tax, and penalties or interests. Total tax liability also includes past taxes from previous years you haven’t paid.

Knowing your tax liability

When you join an organization as an employee, the first day passes as a blur of new faces and names. However, at some point, you’ll need to fill out a W-4 form. This paper determines how much money your employer holds back from your paycheck to cover your taxes.

To find out how much tax you pay, check the slip of paper you get at the time of cashing your check. You’ll also find the pertinent information in your online payroll platform. It’s actually beneficial to look at this data now and then to ensure your withholdings are perfect.

During tax season, if the withholdings from your paycheck are less than the total liability, you must satisfy the government by negating the difference. Conversely, higher withholdings will get you a refund.

You wouldn’t want to pay more in taxes at the end of the year only to get a pocket-warming refund. Why so? Getting a refund means you overpaid the government throughout the year. It’s money you’d have benefitted from keeping in your pocket, don’t you think?

That’s why everyone must understand tax liability. By adjusting your tax withholdings to match the total tax liability, you get zero refund, which you should aim for. Changing the withholdings does feel like you got a raise!

Speak to your employer about adjusting the W-4 form if you end up paying the IRS at the end of the year or get a massive refund. You must ensure you get enough taxes deducted to keep the government off your back.

Things are a bit more complicated for small business owners. You have to estimate your tax liability and make quarterly payments throughout the year. The goal, however, is the same: avoid overpaying or underpaying the IRS.

An example

Let us help you understand the concept with an example. Whenever there’s a taxable situation, you add to your tax liabilities. The most common one is the earned income. Your taxable income will be broken into income ranges or income brackets. Each range will be taxed at a specific rate.

Suppose, as a single filer, $60,000 is your yearly gross income. The standard deduction is $13,850, which leaves you with $46,150 in taxable income. As a result, you’ll be put into the 22% tax bracket. Ultimately, you have to pay around $10,000 in taxes. Or do you?

Here’s the best part: regardless of the bracket you become part of, you don’t have to pay that percentage value on your income. You only need to part with the portion landing in the said range. The government will cut taxes from the rest of income at the lower rates of every bracket your income fills up.

So, for the first $11,000, only 10% will be taxed. For the second portion, which is somewhere between $11,000 and $44,725, only 12% will be taxed. Everything above $44,725 will be taxed at 22%. Your grand total in taxes amounts to $5,460.50.

It’s a very simple example. Besides, other factors, such as exemptions, deductions, and tax credits, can dictate your total tax liability. That’s when things get blurry. Don’t worry, though. You can reach out to a professional to aid you in tax planning, support you to cover the bases, and help you sleep easy at night.

Searching for tax liability

Now, it’s time to find out how to locate your tax liability on the 1040 form. The IRS has been attempting to introduce a few changes to the 1040 form over the past few years to make filling it out easier. Nonetheless, it’s a government form with many intricacies. That being said, here’s where you’ll find your total tax liability.

Line 24 displays the total tax owed for the current year after credits and deductions. Don’t be alarmed! It’s is the amount you’ll pay before subtracting the sum you paid through the year via withholdings.

Line 25 is where you enter the value you’ve already paid. Add to it the amounts withheld from 1099s, W-2s, and other forms showing you didn’t hold back what you owed to the government.

List all the other payments you made and extra credits you may claim on lines, starting from 26 to 31. Add the values of lines 25, 26, and 32 to determine how much you’ve already parted with in taxes and additional credits. The total value will go on line 33.

If line 24 subtracted from line 33 equals zero, you’ve made it! You don’t owe the government anything and you won’t receive anything. Similarly, if the value of line 33 exceeds line 24, you’ll be refunded.

Don’t forget that you must compensate the amount owned if line 24 exceeds line 33. Don’t forget the IRS went easy on you, either. If the amount is above $1,000, you’ll be penalized further on your tax bill.

Reducing tax liability

There’s a way to reduce tax liability. All you need to do is to leverage deductions and tax credits you’re eligible for. These two things can reduce taxable income and put you in a tax bracket lower than the one you’re in. To be precise, the government will deduct only a small sum of your income.

When it comes to deductions, you can take the standard variant or itemize them. For the former, single filers had to pay $13,850, and married couples $27,700 last year. For the latter, itemization included mortgage interest or property taxes, specific medical expenses, etc.

This year, if your itemized deductions don’t exceed the standard deduction, you may take the standard deduction to ensure only a small sum of your income is taxed.

Another method incorporates using tax credits. These differ from deductions because credits cut down the dollar amount of your entire tax bill after applying the tax percentages.

Reduce tax liability further by contributing to 401(k) or other retirement savings accounts. Just keep in mind that it might not be the best option for you in the long run. After all, you’ll have to pay taxes on what you save when you start using the money after retirement.

Be confident

Everyone hates tax season, period! However, you don’t have to handle everything by yourself. Reach out to us to hire a Tax Accountant in Los Angeles. If the data provided above couldn’t satisfy your question “What is tax liability,” our expert definitely will.

Don’t hesitate to contact us if you think you need an expert tax accountant’s support!

FAQs

What are the consequences of underestimating tax liability and failing to make quarterly payments as a small business owner?

If you’re unable to make tax payments, the IRS will impose penalties on you for underpayment of estimated taxes. This will add to the interest from each payment’s due date. The penalty rate may change and increase if you continue unpaying the government. Complete failure to pay taxes will prompt the IRS to seize business property or place liens.

How do tax deductions and credits differ in their impact on reducing tax liability?

Deductions cut your taxable income by an amount you qualify for, resulting in a reduced amount of income subject to tax. Credits, on the other hand, directly reduce tax liability for every dollar.

What are some strategies for accurately estimating tax liability to avoid owing a significant amount at the end of the tax year?

You must maintain accurate tax records, use estimated tax calculations, adjust quarterly payments, try tax withholding, or consult a tax expert to manage tax liability throughout the year.

Also Read: How To Report ERC (Employee Retention Credit) On Tax Return 1120s?