Tax Liability: Definition and Calculation Guide

Tax liability is the amount of money you or your business owes the government in taxes. This money is collected to fund the country’s key systems, such as social services, infrastructure, and the military. 

Determining your tax liability helps you stay compliant and pay what you owe on time to avoid penalties. It also ensures you use deductions, exceptions, and credits to keep your tax liability as low as possible. Read on to learn more about tax liability, what types of liability there are, how to calculate your tax liability, and how to reduce it. 

Key Takeaways

• Tax liability is the amount of money you owe in taxes and must pay the government.
• Income tax, sales tax, capital gains tax, payroll tax, property tax, deferred tax, and more may be included in tax liability.
• Tax liability can be payable to federal, state, or local governments.
• You can calculate tax liability using the current year’s tax brackets and deductions.
• Claiming deductions, exemptions, and credits can help you reduce your tax liability.

Table of Contents

• What Is Tax Liability?
• 6 Types of Tax Liability
• How to Calculate Tax Liability
• How to Reduce Tax Liability
• How FreshBooks Simplifies Tax Management for Businesses
• FAQs About Tax Liability

What Is Tax Liability?

Tax liability is the amount of money an individual, entity, or business owes the government in taxes at the end of the year. It can include various tax types, such as income, sales, capital gains, and more. 

Calculating your tax liability involves considering these types to ensure you arrive at the proper figure and stay compliant. You also need to calculate deductions, credits, and exemptions, as these can help lower your tax liability and reduce the amount you owe. Knowing your tax liability can help you improve your business’s financial position and pay less in taxes at the end of the year.

6 Types of Tax Liability

When calculating your tax liability, consider 6 different types: Income, sales, capital gains, property, payroll, and deferred.

1. Income Tax Liability

Income tax liability depends on the income you earned during the year and includes 3 different types of liability:

1. Federal income taxes: You pay these taxes to the federal government via the Internal Revenue Service (IRS).
2. State income taxes: You pay these taxes to the state government. Certain states do not have state taxes. 
3. Local income taxes: You pay these taxes to local governments, including county, town, and city. Some localities do not have local taxes, while others may have county, city, or both. 

Your federal income tax liability depends on your income for the year. Calculate your earnings against the applicable tax rates using the set tax brackets. If your income is low enough, you may have no income tax liability and tax payable. 

2. Sales Tax Liability 

Consumers pay sales tax anytime they buy something. If you run a business collecting sales tax on the goods or services you sell, you have a sales tax liability. You must calculate your revenue figures and determine how much sales tax you collected. Then, you can remit this amount in a payment to the appropriate state or local government. Four states, Delaware, New Hampshire, Montana, and Oregon, don’t have sales tax. 

3. Capital Gains Tax Liability 

Capital gains tax liability is money you owe because an investment has yielded profits. After you’ve sold the investment, it’s due in the tax year you made the sale. You calculate the tax on the difference between the purchase price and the price you sold the investment for. In other words, you owe tax on the profit you made from the sale.

Capital gains taxes are calculated 2 different ways, depending on how long you owned the investment before selling.

1. Short term: The short-term capital gains rate applies when you own the asset for under a year before selling. You calculate this as though the profit is part of your usual income. 
2. Long term: The long-term capital gain rate applies when you own the asset for over a year. It may vary based on your filing status and taxable income for the year and can be 0%, 15%, or 20%. 

4. Property Tax Liability 

Property tax liability is money you owe based on the value of your property. This most often refers to real estate but can include vehicles and occasionally business equipment and inventory. Property taxes are usually a local tax liability, with the money used to maintain the infrastructure of your county, city, or town. You calculate your property tax liability based on:

• the value of your property
• the property tax rate, which is usually a percentage of the property’s value
• any subsidies and exclusions that minimize your property taxes

5. Payroll Tax Liability 

Payroll tax liability is money you owe on payroll-related expenses you haven’t yet paid out. It includes payroll taxes that the business has withheld from employees’ wages to remit to the government, such as:

• contributions to Medicare, Social Security, or unemployment 
• federal income tax

6. Deferred Tax Liability 

Deferred tax liability is an amount you owe as taxes but can pay later. A typical example is income you put aside in retirement savings, like a 401(k) contribution. The IRS doesn’t include this money in your taxable income for that year, so it doesn’t tax it at that time. Instead, you’ll owe the tax when you withdraw those funds in the future. This deferral can allow you to pay a lower tax rate, as your annual income will be lower during retirement. 

How to Calculate Tax Liability

Your tax liability can be calculated by first calculating your taxable income. Then, use the tax brackets and standard deductions for the current year to discover the amount of tax you will owe.

The 2024 standard deductions are:

• $14,600 for a single filer
• $14,600 for a married couple filing separately
• $21,900 for heads of household
• $29,200 for a married couple filing jointly

The 2025 standard deductions are:

• $15,000 for a single filer
• $15,000 for a married couple filing separately
• $22,500 for heads of households
• $30,000 for a married couple filing jointly

Your adjusted gross income is your total income minus deductions. By calculating it, you can determine your tax liability. To calculate your adjusted gross income, subtract the standard deduction amount that fits your situation from your earned income. The remaining balance is the amount the IRS will tax you on. The tax bracket ranges are updated yearly to stay consistent with inflation.

For example, if your tax filing status is a single filer with an income of $90,000 in 2024, you would use the single filer deduction of $14,600. After this deduction, your reportable gross income would be $78,400, putting you in the over $47,150 tax bracket. Calculate your tax liability for each of the tax brackets your income falls into by using the following federal income tax rate system:

• the first $11,600 is taxed at 10% = $1,600
• $11,600–$47,150 is taxed at 12% = $4,266
• $47,150–$100,525 is taxed at 22% = $9,427

Add these numbers to calculate your total federal income tax liability for 2024 if you have no deductions or other income: $1,600 + $4,266 + $9,427 = $15,293.

2024 Tax Brackets

Tax rate	Single filer in 2024	Married filing separately in 2024	Married filing jointly in 2024	Head of household in 2024
10%	$11,600 or less	$11,600 or less	$23,200 or less	$16,550 or less
12%	Over $11,600	Over $11,600	Over $23,200	Over $16,550
22%	Over $47,150	Over $47,150	Over $94,300	Over $63,100
24%	Over $100,525	Over $100,525	Over $201,050	Over $100,500
32%	Over $191,950	Over $191,950	Over $383,900	Over $191,950
35%	Over $243,725	Over $243,725	Over $487,450	Over $243,700
37%	Over $609,350	Over $365,000	Over $731,200	Over $609,350

2025 Tax Brackets

Tax rate	Single filer in 2025	Married filing separately in 2025	Married filing jointly in 2025	Head of household in 2025
10%	$11,925 or less	$11,925 or less	$23,850 or less	$17,000 or less
12%	Over $11,925	Over $11,925	Over $23,850	Over $17,000
22%	Over $48,475	Over $48,475	Over $96,950	Over $64,850
24%	Over $103,350	Over $103,350	Over $206,700	Over $103,350
32%	Over $197,300	Over $197,300	Over $394,600	Over $197,300
35%	Over $250,525	Over $250,525	Over $501,050	Over $250,500
37%	Over $626,350	Over $375,800	Over $751,600	Over $626,350

How to Reduce Tax Liability

By using applicable tax deductions and tax credits, you can reduce your total tax liability and the amount of tax you owe. There are several strategies you can use to do so.

Maximize Deductions and Claim Credits Against Your Taxable Income

When you file, claim all the relevant tax deductions and tax credits. Deductions can include:

• business expenses, including use of your car or home for business
• education deductions
• healthcare deductions
• investment deductions
• other itemized deductions

Some of the available tax credits may include:

• education credits
• family credits or dependent credits
• homeowner credits
• healthcare credits
• savings and income credits

Contribute to a Retirement Savings Plan  

You can also reduce your tax liability by contributing to a retirement savings plan, such as a 401(k) or an individual retirement arrangement (IRA). These plans allow you to add pre-taxed dollars, which will be taxed when you withdraw the money, allowing you to reduce your current taxable total income while preparing for your future. 

Make Charitable Donations 

You can make charitable donations to qualified charities and obtain a donation receipt. If you itemize your deductions, you can write off this donation as a deduction and use it to reduce your taxable income amount. Donations lower your tax liability while allowing you to support worthy causes. 

Review and Adjust Payroll Withholdings

You can ask your employer to withhold more tax from your payroll over the year, meaning you’ll owe less at tax time because you’ve paid more upfront. Do this by filing a new W-4 form with your employer.

How FreshBooks Simplifies Tax Management for Businesses 

Calculating your tax liability and managing your business taxes can be complicated. Expert help like FreshBooks can save you stress, ensure compliance, and keep your tax bill as low as possible come tax day. 

FreshBooks can streamline your process with features like automated expense tracking software, customizable invoicing with our invoicing software, and financial reporting. FreshBooks makes it simple to track your expenses with mobile receipt scanning, bank account imports, and automatic expense categorization, allowing you to quickly sort through your write-offs and know where you stand ahead of tax day. Automating the work ahead of time streamlines your tax preparation and gives you real-time feedback so you can adjust your choices to maximize your expenses and get the most tax savings possible.

The software lets you skip the spreadsheets, ensure more peace of mind around accuracy, and save up to 6.8 hours each month as you automate expense tracking. The mobile receipt scanning makes it simple to auto-capture the merchant, totals, and tax details, so you’re sure you won’t miss a deduction.

Ready to make tax season more manageable? Try FreshBooks for free.

FAQs About Tax Liability 

Are you still wondering about how tax liability affects you? Check these frequently asked questions to find common answers:

What Is the difference between a tax liability and a refund?

A tax liability is money you owe to the government. A refund is money the government owes you, usually because your employer withheld more from your payroll than was necessary to cover your tax liability.

What is my tax liability if I get a refund?

Your tax liability would be the total amount your employer withheld from your payroll to pay taxes minus the tax refund amount. You calculate this amount on your Form 1040.

What Is tax liability coverage?

Tax liability coverage protects against certain supportable tax positions that don’t qualify for the anticipated tax treatment. In other words, it gives you coverage against owing more taxes than anticipated if the government challenges your tax position. It can also provide coverage of the costs of defending your position.

What happens if I don’t pay tax liability?

Suppose you don’t pay your tax liability. In that case, the IRS can impose penalties that might include interest charges, penalty charges, and even jail time, depending on the severity of the case. 

What does no tax liability mean?

No tax liability means you aren’t required to file a tax return or have no taxable income for the year and don’t owe taxes.

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