One aspect of being an investor is operating within the framework of the law. Obviously, you want to make investments that provide a positive return on your initial investment, but how you manage those returns may be even more important. The Federal Tax Code, while it does provide some tax breaks and deferral options, is clear about one thing: when you owe the federal government taxes, they want their money. Understanding how to determine when and if you owe taxes and the consequences of not doing so is one aspect of becoming an informed investor in any industry.
What Is a Tax Liability?
Tax liability is the payment that is owed to the federal or state government by a person, business, or other entity. In most cases, a tax liability is incurred when an investment is sold, or income is earned. While the phrase “tax liability” may not be one that you’re familiar with, it is really just the legal way of saying that you owe taxes. For instance, you know that if you hold a position within a company, you have to fill out your federal income tax return. The amount of money that you owe the state and federal governments is your tax liability. Additionally, if you sell something that you’ve invested in, whether it’s a mutual fund or a piece of real estate, you will be required to pay taxes on the profits generated in most cases.
What Happens if a Tax Liability Isn’t Paid?
Many people quickly assume that if you fall behind on your tax liabilities you will automatically be in a position to face hefty fines or face federal prison. While there are some cases where that’s true, that’s not the default response to unpaid tax liabilities.
The federal government can pursue charges against you if you have the money to pay your taxes and refuse to do so. Additionally, you may face criminal charges if you lie about how much money you’ve earned within a given tax year. However, if you find yourself in a financial position where you’re not able to pay your taxes, it is highly unlikely that the government will pursue criminal charges against you.
If you file your taxes and then fail to try to make payment, you may face up to five years in prison. If you refuse to file a tax return, you can face up to one year in prison for every year you don’t file. However, if you’re unable to pay the taxes you owed, there are other options for you.
If you are unable to pay your taxes, the IRS will often allow you to set up a payment plan. While there may be interest rates and other penalties to consider, this does present you with an opportunity to catch your taxes up without having to worry about your wages being garnished, property being seized, or any criminal proceedings.
How Do I Know if I Have a Tax Liability?
Ultimately, you have a tax liability if you have earned income within a tax year. Additionally, you have a tax liability if you have sold an investment and generated a profit. However, there are breaks within the Federal Tax Code that can offset those earnings.
One of the best ways to know whether or not you have a tax liability is to work with an accountant or other tax professional. He or she can work with you to help you identify any areas where you can defer or offset your earnings. Additionally, they can help you understand what sort of tax liability you have.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.