How Does Tax Liability Work?

Aug 26, 2022 By Triston Martin

Tax liability is the sum a person, business, or other entity owes to a federal, state, or municipal taxing authority. A tax burden is typically created when an investment or other thing that produces money is sold. One could be compelled to pay a local or state sales tax when making a purchase.

The United States does not impose a national sales tax, even though some countries do. A person might not owe any income taxes if their total tax liability was zero or if their income was insufficient to need filing tax returns.

There Are Numerous Taxing Authorities.

An individual, business, or entity's entire tax debt to a taxing agency like the Internal Revenue Service is their tax liability (IRS). Sales taxes, capital gains taxes, and income taxes are all forms of taxation.

The federal, state and municipal governments are only a few of the taxing bodies that impose taxes. These organizations offer services such as defending and preserving the nation's infrastructure with the funds earned.

Finding Out How Much Tax You Owe

Governments collect taxes at all federal, state, and municipal levels. They use the funds earned to fund things like defending the country and maintaining the roads.

When a taxable event happens, the taxpayer must be informed of the event's tax basis and the applicable tax rate.

Tax obligations include things like payroll taxes and sales taxes. In many states and municipal governments, consumers are required to pay a sales tax, a percentage of each sale. Every month or every three months, firms transmit sales taxes to the taxing authorities. Employers promptly send the income tax, Social Security, and Medicare deductions from employees' paychecks to the federal government.

A person's or a company's tax obligation goes beyond the current year. Considered are any years for which taxes are due. That suggests that the tax debt includes any back taxes (taxes that are still outstanding from previous years).

Examples of Tax Liability

The most common tax debt for Americans is the tax on earned income. Let's imagine that Anne has a gross income of $60,000 at the end of the year, which is reported on an IRS W-2 form.

According to 2020 tax rates, Anne would owe $8,949 in taxes overall, with a federal tax rate of 22% applied to that income.

In particular, Anne would be required to pay 10% on the first $9,950 in income, 12% on the subsequent $30,575, and 22% on the remaining $19,475.

Residents and business owners in Louisiana and a few locations in Mississippi, New York, and New Jersey gained extensions on their IRS filing and payment various areas of Kentucky also received extensions. Visit the IRS's disaster relief announcements to see whether you're eligible.

Gains on Capital are Taxed

When taxpayers sell assets, real estate, or any other item for a profit, they are compelled to pay taxes on the gains.

Take Jamal, who spent $10,000 on 100 shares of XYZ common stock before selling them for $18,000 five years later. The $8,000 gain is the tax basis for this taxable event. The purchase, in this case, reflects a long-term capital gain because the stock was held for longer than a year.

The capital gains tax rate may differ from income and other tax rates. If the tax rate is 10%, Jamal will disclose the $800 tax burden on his individual 1040 tax return.

Specific Considerations

Filled out the Form 1040? On line 16 of page two of Form 1040, you can see the total amount of taxes you owe the IRS. At first, that sum could appear excessive, making your stomach turn. Your tax liability is adjusted for federal income tax withheld, This adjustment results in the amount of current due and unpaid taxes.

If you overcharged, you get a refund. If you pay too little, on the other hand, you will owe the IRS more money.

Tax liability illustration

The most typical kind of tax obligation is on earned income. Franz's gross income of $50,000 is declared on a W-2 form to the Internal Revenue Service (IRS). Franz's paycheck has a $10,000 income tax obligation at a federal tax rate of 20%.

Franz's employer deducted $8,000 in federal taxes according to his W-4 form and paid a $1,000 tax payment throughout the year. The remaining tax payment payable when he submits his Form 1040 individual tax return is $1,000. If, on the other hand, Franz's company only deducted $5,000 and he didn't make any further payments, Franz would now owe the IRS $5,000.

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