At the end of the day, you are fully responsible for ensuring you pay what you owe to the Internal Revenue Service, even if your employer withholds the estimated amount of taxes on your behalf. For that reason, you need to learn how to determine total tax liability. Understanding the total amount you owe in federal income tax will ensure you stay out of trouble and avoid IRS tax penalties.
What Is Tax Liability?
Your total tax liability for the year is the sum of what you owe the IRS at the federal level and other types of tax liability to state and local governments. All your earned income from wages, social security, self-employment, partnerships and capital gains tax from investments help to determine the liability. Also, your tax deductions, credits and your self-employment tax, if applicable, will play a role in what you owe the government. So does your filing status and tax bracket for the various income tax rates.
Therefore, when you determine tax liability, you must understand how the stated factors influence how much you owe. And bear in mind that the amount will vary each year, depending on what you make, laws that have been passed and what deductions you claim.
How to Figure Out Income Tax Liability
Below are tips to determine the estimate of total tax liability for the year.
Determine Taxable Income
To determine your taxable income, find out the total taxable earnings you have made for the tax year for which you are filing taxes. The IRS sets out rules on what constitutes total income and what is exempted by law from taxation.
Generally, employment compensation, such as fringe benefits, tips and stock options, are taxable. Also, the fair market value of bartered services is taxable. And so are cryptocurrencies, rental incomes, royalties, etc. On the other hand, amounts meant for elective deferrals and house allowances for the clergy are not taxable.
Calculate Deductions and Credits You Qualify For
Deductions refer to the specified amounts of money that you can subtract from the total personal and business taxable earnings before applying the set taxation rates. On the other hand, credits will be subtracted from the total taxes you owe and reduce the final amount the IRS ends up with.
You can either take the standard deductions or opt for itemized deductions. These deductions depend on your filing status and apply to most taxpayers. For the tax year 2022, the IRS has set the standard deduction at $12,950 for singles or married filing single taxpayers, $19,400 for heads of households and $25,900 for couples filing joint returns.
If you choose to itemize, then you should deduct every qualified expense individually from your taxable earnings. For example, you can claim deductions up to 60 percent of your adjusted gross income (AGI) when you make contributions to qualified charitable organizations. Other itemized deductions you can claim for the current year include state and local taxes, mortgage interest, real estate taxes on your home and medical expenses exceeding 7.5 percent of your AGI, etc.
Tax credits available include disability credits, those for qualifying children and relatives you support, children with disabilities, business research, etc.
Use the Tax Liability Formula
This is the tax liability formula you can use to figure out what you owe in taxes at the federal, state and local levels:
Total Tax Liability = Taxable Income – (Permitted Deductions + Permitted Credits)
Reporting Your Tax Liability
For individual taxpayers, the total tax bill is easy to calculate when using IRS Form 1040 income tax return. Once you include all the relevant information concerning your taxable earnings, credits and deductions, you can add up all you owe the federal government or the amount of your tax refund based on what payroll tax payments your employer withheld and any estimated tax payments you have made.
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