What is Tax Liability? Understanding Your Financial Obligations

• Your tax liability is the total amount of taxes you owe to the IRS or your state government each year.
• Your income tax liability is determined by your earnings, filing status, deductions, and credits.
• Certain deductions can lower the amount of income taxed, and credits can further reduce how much you owe.

Most Americans who earn an income are responsible for giving a cut to the government.

The total amount you owe a federal, state, or local taxing authority for the year will depend on your tax-filing status and earnings. It's known as your tax liability.

What is tax liability?

Definition of tax liability

Your tax liability is the amount you owe to the IRS or your local government.

If you add up every dollar you earned in a year and take a look at your tax bracket, you will likely get a higher number than what you're actually responsible for paying. The tax code includes a number of deductions and credits that reduce what you actually hand over.

Importance of understanding tax liability

Understanding how much you owe the federal government, and how much you're ultimately responsible for paying, can help you make smart financial decisions.

It can help you avoid over- or under-leveraging your income, for example. A business owner who is aware of the deductions available to them may be able to invest more in growing their business, aware that some of the costs will be offset later.

How tax liability works

Most people who work a traditional job get help from their employer to manage their tax liability.

When you start a new job, you'll fill out Form W-4. This tells your employer how much to withhold from your paychecks for income taxes based on your filing status, family situation, and any additional jobs you have.

Your employer sends the amount withheld for income taxes from each paycheck to the IRS on your behalf because the U.S. has a pay-as-you-go tax system.

At the beginning of each calendar year, you'll receive a W-2 — or 1099, if you're an independent contractor — from each employer you had, detailing how much you earned and how much was withheld for taxes. Self-employed taxpayers generally pay their taxes quarterly rather than through withholdings.

When you prepare your tax return, you may be able to claim various tax deductions and credits, which will reduce your tax liability. If you paid more in taxes than you owe, you'll get a refund.

Types of tax liabilities

Federal income tax liability

The U.S. tax system is progressive. That means the government taxes different portions of your income at different rates that become increasingly higher as the total amount of income rises.

Additionally, certain deductions will reduce the amount of your income that's subject to tax. And certain credits can directly impact the refund amount.

Each filing status has its own tax brackets, although married couples filing jointly and qualifying widow(er)s use the same tax table. These represent the rates at which the individual or couple's income is taxed as they reach certain thresholds.

Below are the tax brackets for single filers, head of household filers, and married filers that apply to income earned in 2024. They're adjusted each year for inflation.

2024 federal income tax brackets

State and local tax liability

In addition to paying federal income taxes, most Americans have to file a tax return with their state of residence to calculate their state income tax liability as well as any local tax owed. State governments impose income taxes in one of two ways: a flat tax or a graduated/progressive tax.

The states with the highest income tax rates — California, Hawaii, and New York — all have graduated tax rates with a top marginal rate of more than 10%.

There is no income tax and no tax on W-2 income in Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming.

Payroll tax liability

Federal payroll taxes are collected directly from employees' paychecks to fund Social Security and Medicare at a total rate of 7.65% (an equal amount is contributed by the employer on the worker's behalf). Most of that goes toward Social Security — in 2024, the rate is 6.2% on the first $168,600 of earnings.

State and local governments may also impose a payroll tax to pay for municipal programs and projects. You should see a breakdown on your paystub of each payroll tax amount and the collector.

Self-employment tax liability

Self-employed people have to pay both portions of the payroll tax for Social Security and Medicare, resulting in a combined 15.3% tax rate on the first $168,600 of earnings. However, self-employed people are eligible for a deduction for half of the tax (otherwise known as the employer's portion).

Self-employed taxpayers are responsible for paying both income and payroll taxes quarterly rather than through withholdings.

Property tax liability

Homeowners are responsible for paying property taxes, which are generally calculated as a percentage of a home's value. Depending on where you live, you may owe state, county, or city property taxes — or a combination of all three.

Sales and use tax liability

Retailers are responsible for charging sales tax on purchased items, but the rate is determined by state and local governments. Some states exempt certain goods and services from sales tax, such as groceries or prescription medicines, and/or impose a tax base.

According to the Tax Foundation, 45 states impose a state-level sales tax.

Taxpayers who live in states without a state income tax may be able to deduct sales taxes paid as part of the SALT deduction on their federal tax return, up to $10,000 per year.

Calculating your tax liability

Determining taxable income

You can estimate your tax liability for the year by adding up all your income and subtracting any applicable deductions, and then applying that figure to the tax tables for your filing status.

For example, if you contributed to a health savings account (HSA) or an employer-sponsored retirement plan that allows pre-tax deferrals, those amounts won't be included in your taxable income.

Further, if you paid interest on student loans or are self-employed and paid health insurance premiums throughout the year, for example, you may be able to subtract those amounts from your gross income. These are referred to as adjustments to income, or above-the-line deductions. This results in your adjusted gross income (AGI).

From there, you can subtract either the standard deduction — $14,600 for single filers and $29,200 for married joint filers in 2024 — or itemized deductions (like mortgage interest or state and local taxes), whichever is higher. This brings you to your total taxable income. That's the figure the IRS applies to the tax brackets to determine your tax liability.

Applying tax rates

Say you're a single filer with taxable income of $75,000 for 2024. Your top tax rate will be 22%, but not all of your income will be taxed at that rate. Here's how it breaks down when you apply the tax tables:

• 10% tax on the first $11,600 = $1,160
• 12% tax on the next $35,550 = $4,266
• 22% tax on the next $27,849 = $6,126.78
• Total tax liability: $11,552.78

Calculating the bill or refund

When you prepare your tax return, you'll compare the taxes you already paid to your total tax liability. If it turns out you overpaid, you'll likely get a refund. If the opposite is true — your tax liability is more than the amount withheld or paid through quarterly payments — you'll have a tax bill. That's your tax due.

Managing your tax liability

Strategies to reduce tax liability

If you qualify for tax credits, you can apply them to your tax bill to lower the amount due on a dollar-for-dollar basis. Some credits are even refundable, meaning that if their total value wipes out your tax bill completely, you can get the excess money attributed to the credits back as a tax refund.

Paying your taxes

If there are changes to your financial situation during the year, you may want to resubmit your W-4 to your employer to make sure the correct amount of money is withheld to cover your tax liability.

If you calculate that you owe money after preparing your tax return, be sure to pay the outstanding amount by the April 15 deadline or you will likely face late payment penalties. If you can't afford to pay it in full, explore the IRS' payment plans.

Self-employed individuals can assess their tax liability through the use of tax planning or hiring a tax professional.

Handling audits and disputes

The IRS can go back as far as three years to audit your tax return if it identifies an error (and even further if there is fraud or major underreporting). Typically, most audits are initiated within two years of the filing date.

Taxpayers have a right to disagree with the IRS' assessment and a right to representation if the matter goes to court.

FAQs on tax liability

What is the difference between tax liability and tax due?

The difference between tax liability and tax due is that tax due is how much you owe the government after falling short of your tax liability. This can happen if you're a W-2 employee, for example, and did not have enough of your paycheck withheld for taxes throughout the year. Tax liability is how much you owe in taxes.

How can I find out my current tax liability?

To find out your current tax liability, you can use a federal income tax calculator.

What happens if I don't pay my tax liability?

If you don't pay your tax liability, you'll face penalties. The outstanding amount will also accrue interest. Penalty relief may be available if it's your first tax penalty or if your ability to pay or file on time was impacted by a serious illness, natural disaster, or other disruptive event.

Can I reduce my tax liability legally?

Yes, you can reduce your tax liability legally by using tax credits and tax deductions.

How do tax credits affect my tax liability?

Tax credits affect your liability by offering a dollar-for-dollar reduction of your tax bill. Think of it like using store credit at a retailer.