Definition and Examples of Tax Liability
Your federal tax liability is the amount of money you owe to the U.S. government in a given year. It's based on the rules set by the Internal Revenue Service (IRS).
Preparing and filing your income tax return will tell you your tax liability for the tax year for which you're filing. Anything that remains unpaid from previous years should be added to what you owe on that return. This ascertains your total tax liability. It's included in your tax liability if you entered into an installment agreement with the IRS to pay off last year’s tax debt and you haven’t yet made the final payment on that agreement.
You can find your tax liability for the year on lines 37 and 38 of the 2021 IRS Form 1040. Appropriately, line 37 says, "Amount you owe.” Line 38 is dedicated to any penalty you might also owe for making your estimated tax payments late.
Technically, line 24 is your total liability for the tax year. But the IRS probably already has some of that money, either through tax withholding from your paychecks or because you've made quarterly estimated payments. It's line 37 that you have to concern yourself with because the IRS still wants that balance.
You can deduct paycheck withholding and any estimated tax payments you made from your total tax to arrive at your tax liability.
Payments you've already made to the IRS appear on line 33. The difference between this and line 24 will either appear on line 34 as an overpayment, indicating that you'll be receiving a refund, or on line 37 as a balance you still owe.
How Does Tax Liability Work?
Your employer likely deducted a percentage from your pay all year for taxes, according to the information you submitted on your Form W-4. They sent this money, your withholding, to the IRS on your behalf. The amount appears on line 25a of your 2021 tax return.
You might have made estimated tax payments during the year if you’re self-employed, or because you enjoyed some source of unexpected income from which taxes weren't withheld. These payments are made using Form 1040-ES, Estimated Tax for Individuals. The amount you paid should be entered on line 26 of your 2021 1040 tax return, the return you'll file in 2022.
All these payments are subtracted from the number that appears on line 24 to arrive at your tax liability.
You can expect a refund from the IRS if the difference between taxes paid and your total tax liability results in a negative balance.
You would receive a refund of $2,500 if your tax liability was $5,000, but the total of your payments and any refundable tax credits you qualified for was $7,500. You'd still owe the IRS $1,000 if your liability was $5,000 and you only made $4,000 in total payments.
Factors That Affect Your Tax Liability
Income tax is the largest component of tax liability for most people. It’s determined in part by tax brackets, the percentage of each portion of your income that you must pay in taxes. These percentages vary depending on both your filing status and how much you earn.
You'd be in the 10% tax bracket in 2022 and your income tax liability would be $1,020 if you’re single and you were to earn just $10,200. You would be pushed up into a 24% tax bracket on the portion of your income that exceeds $89,075 if you were to earn $95,000.
Your tax liability isn't based on the total money you earn in a given year. It's based on your earnings minus the standard deduction for your filing status, or your itemized deductions if you decide to itemize instead. It's also based on any other deductions or tax credits you might be eligible to claim.
The Internal Revenue Code (IRC) allows you to whittle away at your taxable income so your tax liability isn't based on your entire earnings but rather on your taxable income.
The standard deduction has increased for single filers from $6,350 in 2017 to $12,950 in 2022. It, too, is indexed for inflation. Using the hypothetical $10,275 single taxpayer earnings for 2022, subtracting the $12,950 standard deduction would leave a negative balance—and zero tax liability.
You might also make certain adjustments to your total income on Schedule 1, "Additional Income and Adjustments to Income." These would be in addition to the standard deduction or itemized deductions you can also claim. They include things like educator expenses, the student loan interest deduction, and a portion of the self-employment tax you'd have to pay if you work for yourself.
Tax credits reduce your tax liability, too, but in a different way. Deductions subtract from your income so you're taxed on less, but credits subtract directly from what you owe the IRS. Your liability would drop from $5,000 to $4,000 if you're eligible to claim a $1,000 tax credit, just as though you had written the IRS a check for that amount.
It won't just subtract from your tax liability if you can claim a refundable tax credit. The IRS will send you a refund for any balance that's left over after the credit reduces your tax liability to zero. You'll receive the $500 difference directly if you have only a $500 tax liability, and you're eligible to claim a $1,000 refundable credit. But most credits are nonrefundable.
Types of Tax Liability
Tax liability isn’t limited to any income tax you might owe. Technically, the term covers all forms of taxes, such as capital gains and self-employment tax, as well as interest and penalties. Other contributing factors include:
- Interest that's added to your total tax liability if you entered into an installment agreement with the IRS to pay a previous year’s taxes
- An early distribution from a retirement account that was subject to the 10% penalty
- Capital gains tax if you sell an asset for more than your basis in it. Your basis is the amount of your investment in the asset. Long-term gains are taxed at special capital gains rates: 0%, 15%, or 20%, depending on your income (with some rare exceptions). It's a short-term gain if you owned the asset for one year or less. It would be added to your tax liability as ordinary income and taxed according to your tax bracket.
How Much Is My Tax Liability?
The bottom line is that you must pay the balance on line 37 of your tax return as quickly as possible to avoid paying interest and penalties on the amount until it's paid off.
The IRS offers online payment options via Direct Pay or the Electronic Federal Tax Payment System (EFTPS). You can also pay by debit or credit card, electronic funds withdrawal, bank wire, check or money order, or even with cash at certain retail partners.
The IRS offers installment agreements so you can pay off your tax liability over time if you simply don't have the funds to do so right away. Interest will accrue, and there's a modest fee. But it's much better to pay over time than to ignore your debt and hope it goes away.
- Your tax liability is what you owe to the IRS or another taxing authority when you finish preparing your tax return.
- Your tax liability isn’t based on your overall earnings but on your taxable income after you take deductions and claim tax credits.
- Your current year’s federal tax liability appears on line 37 of the 2021 Form 1040, the return you'd file in 2022.
- Your total liability would also include any balances still owed from previous years.