How to Calculate Total Tax Liability

How to Calculate Total Tax Liability
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At the end of the day, you are fully responsible for ensuring you pay what you owe to the IRS, 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 the IRS will ensure you stay out of trouble and avoid 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 the taxes you owe at the state and local levels. All your earnings from wages, self-employment, partnerships and investments help to determine the liability. Also, your deductions will play a role in what you owe the government. And so does your filing status.

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 Tax Liability

Below are tips to determine the estimate of total tax liability for the year.

1. 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 taxable 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.

2. 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 take your deductions either as standard deductions or itemized deductions. These deductions usually depend on your filing status and apply to most taxpayers. For the tax year 2021, the standard deduction is $12,550​ for singles or married filing single taxpayers, ​$18,800​ for heads of households and ​$25,100​ for couples filing joint returns.

If you choose to itemize, then you should deduct every qualified expense individually from your taxable earnings.

For example, as a single taxpayer, you could deduct up to $300​ in cash contributions you make to qualified charities as a single filer even if you claim standard deductions. Alternatively, if you itemize, you can claim deductions up to 100 percent ​of your adjusted gross income (AGI) when you make qualified charitable contributions. And corporations can deduct up to ​25 percent​ of their qualified contributions from their taxable income.

Other itemized deductions you can claim include state and local taxes, mortgage interest, medical expenses exceeding ​7.5 percent​ of your AGI, business expenses, etc.

Tax credits available include disability credits, those for qualifying children and relatives you support, children with disabilities, business research, etc.

3. Use the Tax Liability Formula

Below 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 liability is easy to calculate when using IRS Form 1040. Once you include all the relevant information concerning your taxable earnings and deductions, you can add up all you owe or what is owed to you based on what your employer withheld.