What Is Federal Income Tax Liability?

Federal income tax is the largest source of revenue for the U.S. government, totaling $2 trillion in 2021, and is paid on a yearly or quarterly basis by individual taxpayers and organizations. Federal income tax applies to all forms of earnings that make up your taxable income, including wages, salaries, commissions, bonuses, tips, investment income, and types of unearned income.

Before you make your yearly or quarterly tax payments, you need to be aware of your federal income tax liability. 

What Is Tax Liability?

Tax liability is the amount of money that you owe to the government in a given period. According to the IRS, federal income tax is a “pay as you go” tax and there are two ways to do this: withholding or estimated taxes.

Employers typically withhold portions of wages and salaries to pay individual taxpayers’ liabilities. If this amount is less than the individual’s liability for the tax year, then the taxpayer must pay the difference. If it’s more, then the difference is paid out through a tax refund. 

Individuals, which include sole proprietors, partners, and S corporation shareholders, generally have to make estimated tax payments throughout the year if they expect to owe tax of $1,000 or more when they file their return. 

Filing your income tax return will allow you to find your tax liability for that year and previous years (if you owe). This can be found on lines 24, 37, and 38 of IRS Form 1040. Line 24 states your total liability for the tax year, line 37 states what you owe, and line 38 notifies you of any penalty you might owe for making your estimated tax payments late.

How Federal Income Tax Is Calculated

The federal individual income tax currently has seven tax brackets: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. Your bracket depends on your taxable income and filing status. 

The U.S. uses a progressive tax system, meaning that those with higher taxable earnings pay higher federal income tax rates. However, being in a certain tax bracket doesn’t necessarily mean you pay that rate on all of your income for the year. For example, if you are in the 12% tax bracket, only the income earned in excess of $9,950 in 2021 is taxed at 10% and you pay 12% on the rest.

Minimizing Your Federal Income Tax Liability

There are several strategies that you can use to minimize your federal income tax liability. Understanding tax credits and deductions you may be eligible for can make a huge difference in your tax liability for that year. This enables taxpayers to reduce the amount of gross income that is subject to taxes.

Some popular strategies include:

• Increasing retirement savings account contributions
• Putting pre-tax dollars into an employer-sponsored retirement plan like a 401(k)
• Use capital losses to offset gains through tax-loss harvesting
• Donating to charities and itemizing deductions
• Invest long-term to pay the lowest rate of capital gains tax

For more information about your federal income tax liability and potential ways to minimize what you owe for the year, consult with a CPA or other professional tax expert.