What Is a Tax Liability?

Your tax liability is how much money you owe to the state, local, or federal government. Your income and filing status determine how much you pay.

Because tax liability is the total amount you owe, income tax liability includes the payments you make throughout the year and any money you owe after filing taxes. But other types of tax liability exist. Investors and property owners might need to pay capital gains tax on profits, and business owners might deal with deferred tax liability. 

Here’s everything you need to know about tax liability, including the different types, how to calculate what you owe, and steps you can take to reduce it. 

In this guide:

• What are the types of tax liability?
• How to calculate tax liability
• How do you pay tax liability?
• How do you reduce your tax liability?
• What to do if you have a large tax liability
• FAQ

What are the types of tax liability? 

The different types of tax liability are: federal income, state income, capital gains, and deferred. The type of tax liability determines which government agency you pay and your tax rate. 

The following tax liabilities are among the most common. 

• Federal income tax liability: The federal government collects taxes from taxpayers through the Internal Revenue System (IRS). Unless you earn below a certain threshold, you owe taxes on your income. 
• State income tax liability: Like the IRS, state tax boards collect taxes from residents. The amount varies depending on the state. Several states, including Nevada and Texas, don’t charge personal income tax. The amount you owe to the state government is your state income tax liability. 
• Capital gains tax liability: You must pay the federal government capital gains tax when you sell an asset, such as property or stock. For example, if you earn $5,000 after selling $25,000 in stock shares, your taxed amount is $5,000. Your profit and income tax bracket determine how much you owe. 
• Deferred tax liability: This tax liability relates to businesses and does not apply to individual taxpayers. Deferred tax liability exists when there is a temporary imbalance between the tax amount for a company’s taxable income versus its bookkeeping income. Companies reconcile the difference and pay the taxes. 

Taxes allow federal, local, and state governments to invest in public resources that benefit citizens. These taxes fund roads, libraries, fire stations, public schools, the military, and social services. 

From a business perspective, taxpayers help ensure that the country can run effectively and pay for operating expenses. Ideally, you can benefit from some of the resources your taxes fund. 

How to calculate tax liability

It can help to know how to calculate your tax liability. Most earners pay taxes throughout the year—either through withholdings from their paycheck or quarterly payments if they’re self-employed. 

If you file your tax returns and owe money, that may be a portion of your tax liability but is often not the entire amount. Your tax liability is the total amount of taxes you owe. 

Here’s how to calculate what you owe for each type of tax liability. 

How to calculate federal income tax liability

The United States has a progressive income tax bracket, meaning tax brackets increase as earnings increase. Different portions of your income can be taxed at different rates. 

For example, imagine you’re a single person who earns a $70,000 salary.

• For the 2023 tax year, for the first $11,000 you make, you pay 10% toward taxes.
• For the next $33,725 you make, you pay 12%.
• For the final $30,275, your taxes are 22%.

Here’s how it works: 

Tax rate for a single filer	Taxable income bracket	Tax owed
10%	$0 – $11,000	10% of taxable income
12%	$11,001 – $44,725	$1,100 + 12% of any earnings over $11,000
22%	$44,726 – $95,375	$5,147 + 22% of any earnings over $44,725
24%	$95,376 – $182,100	$16,290 + 24% of any earnings over $95,375
32%	$182,101 – $231,250	$37,104 + 32% of any earnings over $182,100
35%	$231,251 – $578,125	$52,832 + 35% of any earnings over $231,250
37%	$578,126+	$174,238.25 + 37% of any earnings over $578,125

For tax year 2023

How to calculate state income tax liability

State income taxes differ by state. But each state’s tax system falls into one of three categories: flat tax rate, progressive tax rate, or no income tax. How to calculate state income tax liability depends on how your state handles taxes. 

• If your state doesn’t have an income tax, your tax liability is $0. 
• For states that use a progressive tax system, you can calculate it the same way you calculate your federal tax rate. The only difference is in the tax rates. 
• If your state uses a flat tax system, you can calculate your tax liability as a percentage of your earnings. For example, imagine you earn $50,000 and have a flat income tax rate of 4%. In that case, your tax liability is $2,000 ($50,000 x 4%). 

Tax rates vary by state, ranging from 0% to 13.3%. Here’s a look at which states use each tax system:

States with a progressive tax rate	States with a flat tax rate	States with no tax
Arkansas	Arizona	Alaska
California	Colorado	Florida
Connecticut	Idaho	Nevada
Delaware	Illinois	South Dakota
Georgia	Indiana	Tennessee
Hawaii	Kentucky	Texas
Iowa	Michigan	Wyoming
Kansas	Mississippi
Louisiana	New Hampshire
Maine	North Carolina
Maryland	Pennsylvania
Massachusetts	Utah
Minnesota	Washington
Missouri
Montana
Nebraska
New Jersey
New Mexico
New York
North Dakota
Ohio
Oklahoma
Oregon
Rhode Island
South Carolina
Vermont
Virginia
Washington, D.C.
West Virginia
Wisconsin

How to calculate capital gains tax liability

Capital gains fall into two categories: long-term capital gains and short-term capital gains. Short-term capital gains taxes apply to assets you own for less than one year. The tax rate on short-term gains is the same as your annual income. 

But if you own an asset for more than one year, the IRS considers the profit you earn from selling it a long-term capital gain. Long-term capital tax rates are separate from short-term capital gains and are calculated based on your annual income. 

Here are the long-term capital gains tax rates for single filers for tax year 2023: 

Long-term capital gains rate for single filers	Annual income
0%	$0 – $44,625
15%	$44,626 – $492,300
20%	$492,301+

For tax year 2023

Here are the 2023 long-term capital gains tax rates for married filers:

Long-term capital gains rate for married filers	Combined annual income
0%	$0 – $89,250
15%	$89,251 – $553,850
20%	$553,851+

For tax year 2023

How to calculate deferred tax liability

If you run a business with a deferred tax liability, you’ll pay taxes in the future. Deferred tax liability is the amount you still owe. It’s the difference between your financial records and your tax records. 

For example, imagine a technology company sells a computer for $2,000 with a sales tax rate of 8%. The customer pays for the computer in eight installments of $250 over two years ($250 x 8 = $2,000). 

The company owner records a sale of $2,000 in the company’s financial records. However, in the company’s annual tax records, the owner records $1,000 each year for two years. The owner only pays taxes for the first year’s payments. In that case, the company’s deferred tax liability is $80 ($1,000 x 8% = $80).

How do you pay tax liability?

The type of tax liability and how you earn the income determine how you pay your taxes. Regardless of how you pay throughout the year, you must pay any outstanding taxes after you file your tax returns.

Here are the most common ways to pay tax liability. 

• Withholdings: If you’re a W-2 employee, you can elect for your employer to withhold taxes on your behalf. For most taxpayers with a full-time job, this is the easiest option and allows you to pay toward your state and federal income tax liabilities throughout the year. 
• Quarterly estimated taxes: Many independent contractors and freelancers make quarterly estimated tax payments throughout the year, which go toward their state and federal income tax liability. You can calculate the payments based on your earnings and estimated tax rates, including a 15.3% self-employment tax. 
• Tax bill: Other tax liabilities, including capital gains taxes and business taxes, often require an additional form you include in your tax return. For example, businesses file IRS Form 1120, and taxpayers who earn capital gains file a Schedule D form. Once you submit the form with your tax return, you’ll have a tax bill that outlines how much you owe. 

What is a tax refund?

You receive a tax refund if you overpay your taxes throughout the year—typically through W-2 withholdings or quarterly estimated tax payments. It might seem like free money, but tax refunds are money you already earned. You’re getting it back because you paid more than your tax liability. 

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Our expert’s recommendation

Eric Kirste

CFP®

If you are a W-2 employee and get a tax refund, I suggest reviewing your withholdings to ensure you aren’t withholding too much. It might be wise to reduce your payroll deductions. (Other reasons within the tax return could cause the refund, but checking whether you’re withholding too much is wise.) 

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What is a tax bill vs. tax liability?

Your tax liability is the total amount you owe for taxes for the year. 

Your tax bill, on the other hand, indicates how much you still owe in taxes after accounting for deductions, previous payments, and tax credits. 

For example, imagine your total tax liability for the year is $20,000. You choose to have money withheld from your paychecks throughout the year and pay $14,000. After accounting for deductions, you still owe $2,000. Your tax bill for the year is $2,000. 

How do you reduce your tax liability?

You can take steps to reduce your tax liability. The IRS and state governments outline several options for taxpayers to save money on taxes, including deductions, credits, and tax-exempt investments. 

• Tax deductions: Tax deductions reduce your taxable income. The IRS sets a standard deduction as a fixed amount—$13,850 for single filers and $27,700 for married filers in 2023. You can subtract the deduction from your taxable income and don’t need to pay taxes on that portion of what you earn. You can opt to itemize deductions instead, which can be wise if it leads to a higher amount than the standard deduction. Note that items such as age (65 and over) can affect your standard deduction.
• Tax credits: Tax credits lower your tax liability by reducing what you owe. The two categories of credits are refundable and nonrefundable. Refundable credits result in a tax refund if your tax liability drops below zero while nonrefundable credits do not. One of the most popular credits is the child tax credit of up to $2,000 per child. You can also claim credits for adoption, education expenses, and dependent care. 
• Tax-deferred retirement accounts: The IRS also allows for tax-deferred contributions in retirement accounts. Your contributions lower your taxable income, which reduces your tax liability as a result. Eligible accounts include a 401(k), Traditional IRA, and Spousal IRA.

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Our expert’s take: Ways to reduce your tax liability

Eric Kirste

CFP®

Several items can reduce your tax through deductions, but with the passing of the 2017 tax law, most individuals only claim their standard deduction. Also, consider the aforementioned capital gains and capital losses. Any capital losses from selling an investment for a loss (less than you paid for it) are first applied to offset capital gains. If you have additional losses after all your gains are offset, you can take a deduction of up to $3,000 against ordinary income in that year. You can carry unused losses forward to future tax years.

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What to do if you have a large tax liability

If you can’t afford to pay your tax liability, it’s essential to contact the IRS or your state tax board as soon as possible. The IRS offers the Taxpayer Advocate Service (TAS), a free service that works on behalf of taxpayers. TAS can help you resolve tax issues with the IRS, including appeals and payment plans. State tax boards offer similar free services to help you find a solution.

You can also work with a tax relief professional. Tax relief companies contact the IRS on your behalf to resolve your tax issues. 

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Our expert recommends

Eric Kirste

CFP®

Plan for tax liability throughout the year–not just during tax season. Consider annual tax planning, where you or a tax professional create tax projections during the year to determine possible tax optimization strategies, areas where an adjustment is needed, or to spot a missed opportunity. It’s important to perform a projection before the end of the year, but give yourself enough time to act on those adjustments or other strategies. The best times to do tax planning during the year are: One, once you file the prior year’s taxes. When it’s top of mind, that can make it easier to review possible projections or plan for adjustments. Two, the end of the third quarter or beginning of the fourth quarter. Reviewing any possible year-end adjustments to help your taxes for that year can be helpful.

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FAQ

How do I know if I have a tax liability?

You likely have a tax liability if you earn income or sell an asset. Filing your annual tax returns is the best way to determine your tax liability. When you file your tax return and any accompanying required forms, you’ll find out what you owe in taxes. But you might not have to pay taxes if you earn below a certain income. 

Does tax liability differ if I’m self-employed?

Your tax liability is different if you’re self-employed. Instead of having taxes withheld from your paycheck, you can pay estimated quarterly taxes based on your earnings. You also must pay the self-employment tax of 15.3% and helps fund your future Social Security and Medicare benefits. 

Can tax liability affect my credit score?

The IRS does not report tax debt to the credit bureaus. If you owe taxes, it won’t appear on your credit report. But if the IRS or state tax board issues a levy against your assets to collect what you owe, the notice form is a public record, which lenders might be able to view. 

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

The federal or state government issues a tax lien if you don’t pay your tax liability. It’s a notice that the government plans to collect payment. If you still don’t pay, the agency can use a tax levy and begin to seize your assets, including property, bank accounts, and more. If you need help getting out of tax debt, you can contact the Taxpayer Advocate Service or a tax relief company for assistance.