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Taxes

9 Minute Read

What is a Tax Liability?

9 Minute Read

Tax liability on a game board.

Like it or not, taxes are a part of life. And unfortunately, the government doesn’t do too much to help you figure out what you owe. It’s sort of like Uncle Sam says he knows how much you owe him, but won’t tell you—and if you don’t figure it out correctly, he hits you with a penalty. Talk about a pain. Especially if you don’t fully understand what you owe in the first place.

This is where tax liabilities come into the picture. What is a tax liability? Glad you asked.

What Is a Tax Liability?

A tax liability is a tax debt you owe to a taxing authority—aka the IRS, state government or local government. Essentially, if you’re paying taxes on it, it’s a tax liability.

Your total tax liability is the total amount of tax you owe from liabilities like income tax, capital gains tax, self-employment tax, and any penalties or interest. This also includes any past due taxes that you haven’t paid from previous years.

A tax liability is a tax debt you owe to a taxing authority—aka the IRS, state government or local government. Essentially, if you’re paying taxes on it, it’s a tax liability.

Why It’s Important to Know Your Tax Liability

If you have a regular job, you should have filled out a W-4 form with your employer. Based on that form, your employer withholds a portion of your income to cover your tax liability and sends it to the government on your behalf.

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If you’re self-employed or own a small business, you’ll likely be responsible for calculating your own tax liability and sending in quarterly tax payments throughout the year.

Now, if the amount withheld from your paycheck or the amount you send in for the year is less than your total tax liability, you’ll have to cut Uncle Sam a check for the difference come tax season. If your total withholding or payment amount is higher than your total tax liability, then you’ll get a refund.

This is where knowing your tax liability is important—you want to avoid both of those situations. No one wants to owe more taxes when April rolls around, and a refund only means you overpaid for an entire year. Getting your withholding to line up with your income tax liability is the end goal. You want to break even when tax season arrives!

No one wants to owe more taxes when April rolls around, and a refund only means you overpaid for an entire year. Getting your withholding to line up with your income tax liability is the end goal. You want to break even when tax season arrives!

Examples of Income Tax Liability

Anytime there is a taxable event—think earning income, making sales or issuing payroll—you rack up tax liabilities.

Like we mentioned above, the most common type of tax liability is earned income. So, for example, let’s say you earn $50,000 in gross income in a year and you’re a single filer. If you take the standard deduction of $12,400, that leaves you with $37,600 in taxable income—putting you in the 12% tax bracket. Wondering where we got that percentage? Let’s break it down a bit more.

Your taxable income—your gross income after deductions and credits—gets divided into tiers (called tax brackets) that are each taxed at a certain rate.

Below are the federal income tax rates for the 2020 tax year.1

Tax rate

Single

Married, filing jointly

Married, filing separately

Head of household

10%

$0–9,875

$0–19,750

$0–9,875

$0–14,100

12%

$9,876–40,125

$19,751–80,250

$9,876–40,125

$14,101–53,700

22%

$40,126–85,525

$80,251–171,050

$40,126–85,525

$53,701–85,500

24%

$85,526–163,300

$171,051–326,600

$85,526–163,300

$85,501–163,300

32%

$163,301–207,350

$326,601–414,700

$163,301–207,350

$163,301–207,350

35%

$207,351–518,400

$414,701–622,050

$207,351–311,025

$207,351–518,400

37%

$518,401 or more

$622,051 or more

$311,026 or more

$518,401 or more

 

So, to continue with our example above, the first $9,875 is taxed at 10% ($987.50 in taxes). The second portion of your taxable income—anything between $9,876 and $40,125—is taxed at 12%. Since you earn less than $40,125, you’ll subtract the $9,876 from your total taxable income number to see how much of your income falls into that range. That would look like this: $37,600 minus $9,876 equals $27,724. This is the amount that gets taxed at 12% (which comes out to be $3,327).

Now we know that your tax liability on that income would be $4,314.50—found by adding the first bracket at 10% ($987.50) to the second bracket at 12% ($3,327).

On top of that, let’s say you also had a tax bill of $3,000 from the year before that you didn’t pay (bad idea). Your total tax liability would be $7,314.50 ($4,314.50 + $3,000).

This was a pretty basic example, and there are more factors that can also affect your total tax liability—like tax credits, exemptions and deductions—and things can start to get hazy quick. If you feel the room starting to spin, just reach out to a tax pro. They can help clear up the confusion so you can feel confident that you’re covering all your bases (and paying your taxes on time!).

How to Find Your Tax Liability on the 1040 Form

Over the last few years, the IRS has tried to make some changes to the 1040 form in an effort to make it a little bit simpler to fill out. But it’s still a government form with a lot going on—and it looks like there are even more changes inside the 1040 form you’ll use to file your 2020 taxes. All that said, here’s where you can find your tax liability totals this year.

Line 24 shows the total tax you owe for the current year after deductions and credits. But don’t worry—this is the amount you owe before subtracting what you’ve paid throughout the year from withholdings. Phew!

Line 25 is where you fill in how much of your paycheck your employer withheld and sent to the government for you. (Line 25d will show you how much tax liability you’ve already paid off—you’ll find that number on your W-2 or 1099 form.)

Even better news—you can list any other payments you made and additional credits you can claim on lines 26 through 31. Add up lines 25d, 26 and 32 to find how much you’ve already paid in taxes and your additional credits—or your total payments. This total goes on line 33.

Now, if your total tax (line 24) minus your total payments (line 33) equals zero, congratulations! You owe nothing and get nothing back. You covered your tax liability throughout the year. If line 33 (your payments and additional credits) is higher than line 24 (total tax owed), you’ll fill out lines 34 through 36 to calculate and request your refund for the amount you overpaid.

On the other hand, if line 24 is higher than line 33, you’ll fill out line 37 with the difference—the IRS made it easy for you by calling out this line as "amount you owe.” (How thoughtful.) This is your remaining tax liability. And if that isn’t bad enough, if that number is above $1,000, you’ll also have to pay a penalty on top of your tax bill. No thanks.

How to Reduce Your Tax Liability

Hello, deductions and credits! One way to reduce your tax liability is to take advantage of any deductions and tax credits that you’re eligible for. These babies reduce your taxable income and can put you in a lower tax bracket, meaning less of your income will be taxed. Oh, yeah!

When it comes to these deductions, you can either take the standard deduction$12,400 for single filers and $24,800 for married couples for the 2020 tax year—or you can itemize your deductions.2 This includes certain medical expenses, gifts to charity or student loan interest payments, to name a few.

Keep in mind that if your itemized deductions are less than the standard deduction amount, your best route is likely to go ahead and take the standard deduction so less of your income gets taxed. Working with a tax pro can help you be sure you’re making the right call at this step.  

Tax credits are another way of reducing your total tax liability. These are different from deductions because credits reduce the dollar amount of your total tax bill after the tax percentages have been applied. These are things like the child or dependent tax credits, adoption credit, or the first-time home buyer credit.

If you’ve finished Baby Steps 1 through 3, you can also cut down your tax liability by contributing to a 401(k) or other pre-tax retirement account. Pre-tax dollars go into your retirement account and grow tax-free until you start taking out money at retirement age—this means you defer having to pay taxes on this unearned income until then. But remember—this is not an excuse to skip to this step if you haven’t already paid off all your debt and saved up a fully funded emergency fund. A few dollars saved on taxes isn’t worth staying tied to all those monthly debt payments.

And while it may not save on your actual tax liability, checking in on your W-4 with your employer can help you be sure you aren’t paying more in taxes all year than you actually owe. For some people, getting their withholdings set correctly could feel like a raise! You want to make sure you have just enough tax taken out of your paycheck to keep Uncle Sam happy.

While it may not save on your actual tax liability, checking in on your W-4 with your employer can help you be sure you aren’t paying more in taxes all year than you actually owe. For some people, getting their withholdings set correctly could feel like a raise!

File Your Taxes With Confidence

While tax season may never be your favorite time of year, you don’t have to do it all on your own. Reach out to a tax Endorsed Local Provider (ELP) in your area to help you sort out your tax situation—tax liabilities and all! Get ready to walk into the next season feeling like a tax boss. Get a tax pro today!

Feel like your taxes are simple enough to do them yourself? With Ramsey SmartTax, you can! Ramsey SmartTax makes it easy to take control of your taxes and file your tax return in a matter of minutes. You won’t be surprised by hidden fees and you won’t have to make sense of confusing tax jargon—what you see is what you get!

Learn more about Ramsey SmartTax today!

When Are Taxes Due?

When are taxes due? It’s July 15, right? For most people this is true . . . to find out more about when Uncle Sam wants to be paid, read on!

What Are Income Taxes?

No one likes income taxes. But they are as much a part of American life as baseball and apple pie. Here’s what you need to know about income taxes before you sit down to file your taxes this spring.

What Is a Tax Credit?

Want to shave hundreds of dollars off your tax bill? Of course you do! Tax credits can help you reduce what you owe in taxes, and some of them can actually leave you with money in your pocket.

What Is a Tax Deduction?

What if we told you that you could save a chunk of money on your taxes this year? Figuring out what tax deductions you can claim on your return might help you keep a lot more money in your pocket!

Tax Pro or File Your Own?

Take the Quiz

Tax Pro or File Your Own?

Use this free quiz to help you decide which tax filing method is right for you.
 
Take the Quiz

Tax Pro or File Your Own?

Use this free quiz to help you decide which tax filing method is right for you.
 
Take the Quiz