Takeaways
- Tax liability is the amount owed to a federal, state, or local government.
- Tax liability can be from personal, business, or passive income and other gains.
- Tax liability can be reduced by leveraging deductions, credits, and exemptions.
- Tax liability comes from underpayment based on your income and tax brackets.
- Online tax software platforms can calculate your tax refund or liability for federal and state taxes based on your financial situation.
What Is a Tax Liability?
A tax liability is the amount of taxes a person, company, or other entity is legally obligated to pay the government. This liability is owed and paid to either federal tax authorities, like the Internal Revenue Service (IRS), or state and local tax revenue offices. Tax liability can include income taxes, payroll taxes, capital gains taxes, sales tax, property tax, and any other applicable taxes based on your financial situation.
Your personal tax liability is determined based on your income, expenses, deductions, credits, and other relevant tax filing information. For individuals, this means your tax liability is primarily determined by your federal and state taxable income. The tax rates applied to your income vary depending on your tax filing status (Single, Married Filing Jointly, etc.), income level, type of income (W-2, investment, passive income, etc.), and the corresponding tax bracket you fall into.
If you own your own business, you might already be familiar with how business taxes work. The type of entity - C Corporation, Limited Liability Company, or a Nonprofit – matters tremendously to how taxes are calculated. Businesses calculate tax liability based on their net income and other factors, like net operating losses, deferred tax assets, and liabilities.
A tax liability is, above all else, a legal obligation to pay taxes that are owed. Failing to meet this legal obligation can lead to high fees, penalties, interest charges, and other enforcement tactics (like repossessing your home for unpaid property taxes) from the tax authority.
Reporting your taxable income, deductions, and credits accurately is absolutely critical to understanding your tax liability. Effective financial planning and legal tax mitigation strategies can save you thousands of dollars and ensure proper compliance. Using one of the best tax filing platforms, working with a tax professional, and planning are smart money moves.
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How a Tax Liability Works
Tax liability is determined through complex calculations that start with your personal or business income. For individuals, this means adding up all sources of income, from W-2 income, side hustle, stock dividends, interest from CDs, asset sales, or other earnings. You normally owe taxes when you generate revenue and gains from selling assets.
Read More: 7 Types of Asset Classes
Once your taxable income is determined, you will apply the corresponding tax rates to determine your gross tax liability. The U.S. tax system is a progressive system. Different types of income are taxed at different tax rates, which tend to increase with income levels.[1] A progressive tax system means that those earning more income tend to pay a higher percentage and amount of their income in taxes.
Allowable deductions and exemptions are subtracted from your taxable income liability. These exemptions and deductions can include medical expenses, contributions to charity or nonprofits, and a buffet of highly specific tax credits.
You can get a general sense of how much tax liability you owe by subtracting the standard deduction from your taxable income and applying the appropriate tax rate and bracket. Here are the standard deductions for 2024:
| Filing Status | Standard Deduction |
|---|---|
| Single Filers | $14,600 |
| Married Filing Separately | $14,600 |
| Head of Household | $21,900 |
| Married Filing Jointly | $29,200 |
Source: Internal Revenue Service Website [2]
The final tax liability is the net amount you owe the tax authority. If tax prepayments and credits exceed the tax liability, the taxpayer is typically entitled to a tax refund. However, the taxpayer must pay that remaining balance if the tax liability exceeds these prepayments, deductions, and credits.
In 2024, the IRS processed over 136 million individual income tax returns.[3] That number only balloons higher when you add business tax returns. The IRS allows individuals and businesses to pay for tax liabilities through direct deposits, checks, and money orders.
How to Reduce Your Tax Liability
Reducing your tax liability centers around maximizing your deductions, credits, and other tax savings. Here are some common ways to help reduce your tax liability:
- Tax Deductions reduce your total taxable income, lowering the amount of your income subject to your tax bracket. The most common tax deductions are mortgage interest, medical expenses, taxes paid to state and local authorities, and charitable donations. (Read more about tax deductions).
- Tax Credits are a way to reduce the amount of tax you owe. Some of the most valuable tax credits available for individuals are the Earned Income Tax Credit and Child Tax Credit. While deductions lower your taxable income, credits reduce the total amount of tax you owe on a dollar-for-dollar basis. (Read more about tax credits).
- Retirement Contributions are another great way to reduce your tax liability. Consistent contributions to retirement accounts, like a 401(k) plan or Traditional IRA, are tax-deductible, and you can use pre-tax dollars to fund your 401k, which lowers your taxable income for the current year. (Read more about how to retire early).
- Health Savings Account contributions to an HSA account are also tax-deductible. This is a perfect way to put money aside for qualified medical expenses and have your savings grow tax-free. Withdrawals for medical expenses are also tax-free. (Read about how to invest with your HSA account.)
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When Do You Pay Your Tax Liability?
If you are like most U.S. taxpayers, you will pay a tax liability every year. However, depending on your source of income and overall financial situation, you may also need to make periodic tax payments throughout the year.
Personal Income Tax Deadline:
For most individuals, the standard time for clearing up your tax liability is with the annual tax return. If you owe taxes, they must be paid on or before the yearly deadline on April 15. For example, for the tax year 2024, your personal income tax return will be due April 15, 2025.
Estimated Quarterly Payments:
Those who are self-employed, get significant income from non-withholding sources, or expect to owe more than $1,000 are generally required to make quarterly estimated tax payments. Here are when to pay estimated quarterly payments:
| Payment Period | Due Date |
|---|---|
| January 1 – March 31 | April 15 |
| April 1 – May 31 | June 15 |
| June 1 – August 31 | September 15 |
| September 1 – December 31 | January 15 (of the next year) |
Source: Internal Revenue Service Website [4]
Where Does Tax Revenue Go?
Federal, state, and local governments use tax revenues to support all public services, such as regular road maintenance, Social Security, Medicare, public schools, and social programs.
Federal personal and business taxes are generally used to support the federal government’s expansive administration, which can include funding departments like the Labor Department, Federal Food and Drug Administration, and Health and Human Services.
State income taxes support state governments and help implement state rejuvenation projects, state government administration, and comptroller offices. As you might have guessed, local taxes, like property taxes, support local public schools, parks, city-wide cleaning crews, and other initiatives.
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Smart Summary
A tax liability is the amount of taxes you owe to the government. Your tax liability is determined through a complicated series of tax calculations that consider your earned, passive, and investment income and offset your liability through a matrix of deductions, credits, and tax deferment strategies. After you file your taxes, you might have a tax liability, and you owe the IRS, your state, or local government a tax cash payment. You can pay this via online deposit, check, or money order. You can use one of the best online tax filing platforms to file taxes.
Frequently Asked Questions
For the tax year 2024, personal income taxes are due on April 15, 2025.
How you are taxed on your earnings depends on what type you make. W-2 income, freelance income, and side hustle income are taxed as earned income. There is also investment income to consider, and depending on investment rules, these can be determined to be long-term or short-term capital gains, which have varying tax consequences.
When it comes to tax liability for businesses, it works a little differently. The business calculation of tax liability starts with the total revenue and fewer business expenses. Business expenses are wide-reaching, including operating costs, utilities, rent, payroll, and countless other necessary expenditures. Additional deductions and credits, such as research and development credits, can be applied to reduce a business’s taxable income further.[5]
(1) Tax Foundation. Progressive Tax. Last Accessed January 14, 2025.
(2) Internal Revenue Service. IRS provides tax inflation adjustments for tax year 2024. Last Accessed January 14, 2025.
(3) Internal Revenue Service. Filing season statistics for the week of April 19, 2024. Last Accessed January 14, 2025.
(4) Internal Revenue Service. Estimated Tax Payments. Last Accessed January 14, 2025.
(5) Internal Revenue Service. Research Credit. Last Accessed January 14, 2025.
