Generally, individuals, organizations, and corporations all owe taxes to the federal, state, and local governments in which they reside. If you own a business, you are probably aware of tax obligations as an item on your accounting records. If you are an individual taxpayer, you may have heard this tax word before. Today, we will go through not only tax liability’s definition, but also its interesting details. Thus, you can file your taxes appropriately.
List of Contents
What Exactly is Tax Liability?
Tax liability refers to the amount of money that is owed to a federal, state, or municipal tax authority by an individual taxpayer, a business, or another entity. In general, the tax liability is created whenever there is a financial gain, whether it is in the form of a wage or the sale of an investment, or some other type of asset. When something is bought, the buyer would have to pay a sales tax to their municipality or state. However, people may have no income tax burden if their total tax payable was zero or if their income was below the minimum.
Examples of Tax Liability
Earned income tax is the most common type of tax responsibility for Americans. For instance, Anne has a yearly gross income of $60,000. Based on the tax brackets for 2020, Anne’s tax liability would be $8,949, with a 22% federal tax rate on her income. Anne would owe 10% on the first $9,950 of her income, 12% on the following $30,575, and 22% on the final $19,475. Nevertheless, assume Anne’s W-4 caused her employer to withhold $6,500 in federal taxes, and she paid $1,000 in taxes during the year. Anne’s remaining tax payment is $1,449, which is the difference between her $8,949 tax liability and her $6,500 in withholdings and $1,000 in payments.
Types of Tax Liability
1. Small Business Tax Liability
Many taxable events as follows may result in tax liabilities for your company.
- Franchise or excise tax liability is another type of tax burden that many small business owners face.
- If your company meets a paid event, you must pay the proper tax authorities.
- Billable events are transactions that result in taxation.
2. Income Tax Liability
Employers are normally subject to federal income tax, as well as state and municipal income taxes in some situations. The employer deducts income tax from the employee’s salary. However, if you operate a small firm, you will not get compensated. Moreover, if you are not paid, no income tax is deducted from your earnings. Unless you are a formal organization, your income tax liability may include a business income tax. You can also pay your income tax liability in installments throughout the year.
3. Trade Tax Liability
Profits earned by your company must be taxed. However, if you structure your company as a sole proprietorship, partnership, S-Corporation, or LLC, you can take advantage of pass-through taxation. Sales tax is transmitted via the corporation and is then passed on to you via pass-through taxes. As a result, the consumption tax burden is reported on the personal income tax return as income.
As a separate legal entity, your company is required to pay taxes on its profits. Corporate tax is levied in addition to individual income tax. Your company is subject to state corporate income tax.
4. Self-Employed Tax Liability
The self-employment tax includes both the employer and employee portions of the social security and Medicare taxes. You can pay self-employment tax in installments.
5. Payroll Tax Liability
If you employ people, you must pay payroll taxes as well as employment taxes. Your income tax burden is calculated by the money you withhold from your employees and the money you spend as an employer. These taxes must be filed with the IRS in accordance with the deadlines.
6. Consumption Tax Liability
If you sell goods and services to clients, you must collect sales tax. Sales tax will be imposed after collecting it from the customer. You must send a proportion of the customer’s total cost to the state or local government in the form of sales tax.
7. Capital Gains Tax Liability
If you profitably sell an investment or other type of asset, you may be subject to capital gains tax. The difference between what you paid for the asset and what you sold it for is your profit.
8. Property Tax Liability
Property tax is a tax paid by a property owner to a local government that varies greatly. The value of your asset determines your tax liability. Every year, local governments revise tax rates. You can calculate property tax liability by calculating the tax rate by the market value of the property.
How to Reduce Your Tax Liability
Here are a few options to lower your tax bill.
1. Make a charitable donation.
Donating to charity is a popular way to reduce your tax liability. However, it is critical to obtain proper documentation for all donations. Donations, of course, can only be deducted if you itemize your deductions rather than taking the Standard Deduction. For many people, the Standard Deduction provides a larger tax reduction than itemizing, although your limit may vary.
2. Make a contribution to a retirement account.
Saving for retirement is one of the favorite ways to lower tax obligations and plan for the future. Contributions to 401(k)s lower your taxable income. Contributions to Roth IRAs, on the other hand, are made after-tax money and do not lower your tax obligation in the year of contribution.
3. Make changes to your payroll exemptions.
You can also alter your payroll tax exemptions by filing a new W-4 with your employer if you want to minimize your tax payment. If you withhold too little, you will owe more at tax time.
Conclusion
Understanding your tax liability in advance, whether you are a business owner or an individual, can help you avoid the surprises of tax season. However, the unpredictability of taxation is one of the reasons why emergency funds must be maintained. You can entirely cover the difference even if your tax liability varies from year to year.
FAQs
Your tax liability is the taxes owed to the government, depending on your income, deductions, and other financial factors.
Contributing to a retirement account, taking advantage of deductions and credits, donating to charities, and investing in tax-deferred accounts are a few strategies to decrease your tax liability.
Small business owners can minimize their tax liability by utilizing business deductions like home office expenses, travel expenses, and equipment purchases. It is essential to maintain correct records and consult a tax expert to ensure compliance with tax laws and regulations.
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Source: Investopedia