Guide To Calculating Tax Liabilities (With Steps and Types)
Tax liability is an important value that accountants monitor to ensure they can pay the proper taxes for businesses. Many factors affect tax liability, such as business structure, employment type, and pay. Learning the various types of tax liability can help you determine personal and business tax liabilities and calculate them accurately.
In this article, we define tax liabilities, provide steps for calculating them and outline the different types of tax liabilities.
What are tax liabilities?
Tax liabilities are the amount of money a company or individual owes to the government in local, state, and federal taxes. Anytime an individual earns income or a business makes a sale, they must pay taxes on that amount. As a result, individuals have different corporate tax liabilities depending on their income level, while businesses pay different taxes depending on their type.
Employees fill out W-4 forms with their employers, who then withhold the specific amount for taxes and send it to the Internal Revenue Service (IRS). Employers send their employees W-2 forms once a year, which employees use to file their taxes and ensure they don’t owe more or are due for a tax refund.
Businesses make tax payments to the government throughout the year. However, different businesses have varying tax liabilities depending on several factors, such as their type, amount of sales or income, and tax bracket. For instance, C corporations pay only Corporate Tax UAE, whereas other business types, such as sole proprietorships and partnerships, pay taxes at individual rates. Accountants calculate all these factors and make estimates of payments based on their figures.
How to calculate tax liabilities
The following steps can help you calculate tax liabilities:
- Find your tax rate and income
Businesses have different tax rates depending on the entity type. For example, all corporations pay a flat tax of 21%, regardless of how large they earn. In addition, they pay corporate income tax and taxes on profits the company distributes among its owners as dividends. If a business distributes income to its owners, they pay taxes on it when filing their tax return, essentially taxing the income twice. With a flow-through entity, the business owner pays the taxes rather than the business paying taxes.
- Include deductions and tax credits
Deductions have applications in reducing gross taxable income. For example, a business can deduct all its normal running costs from its gross taxable income, which lowers the amount owed in taxes. Some common deductions for a business are internet costs, cell phone costs, mileage on a work vehicle, business meals, and insurance. If you have many deductions, you can itemize them to get the full benefit. However, you might prefer to take a standard deduction if you have a few deductions.
Standard deductions are $12,950 for single taxpayers, $19,400 for heads of households, and $25,900 for married filing jointly. Many tax credits are also available for eligible taxpayers, which can help lower tax liability. It’s important to stay updated on tax credits to ensure you’re determining tax liability accurately.
- Determine employee taxes
Companies must also pay employment taxes. Employees pay some employment taxes, but the company is responsible for withholding the right amount. Self-employment business owners also need to pay a self-employment tax. These are the most common employment taxes:
- Social Security tax equals 12.4% on wages up to $137,700. It’s a requirement to pay only half of this cost for employees and employers, but self-employed individuals pay the full 12.4%.
- Medicare tax: This tax equals 2.9% of all wages. Employees pay 1.45%, and employers pay the other half, but self-employed people pay the full amount.
- Federal unemployment tax: Usually, this is 6% of the first $7,000 of each employee’s wages. You may reduce the percentage to 0.6% by paying into your state’s unemployment fund.
- Estimate the payments
Once you have the tax rate, income, deductions, and employee taxes, you can calculate how much your tax liabilities cost. Add all the numbers, then divide that number by four because businesses make quarterly estimates of the corporate payments. You can use the estimated tax for income, self-employment, and alternative minimum tax.
These tax requirements differ depending on income level. Sole proprietors, S corporation shareholders, and partnership partners pay an estimated tax if they expect to owe $1,000 or more in taxes. Companies must calculate their taxable income, adjusted gross income, credits, taxes, and deductions for the year to determine their estimated tax.
Types of tax liability
The types of tax liability include:
Business tax liability
The federal government requires businesses to pay corporate taxes on their profits. However, some companies may use pass-through taxation, where the business taxes pass to the owners, who then include business income tax liability on their personal income tax returns. These businesses include partnerships, sole proprietorships, S corporations, and limited liability companies (LLCs). C corporations owe taxes on their business profits at the federal corporate income tax rate because they’re separate legal entities from the owners.
Payroll tax liability
Companies are responsible for filing, withholding, and remitting their employees’ payroll taxes. It’s a requirement to withhold federal, state, and local income taxes where applicable. In addition, for employees who earn wages, their companies must withhold Federal Insurance Contributions Act (FICA) and pay state and federal unemployment taxes. Income, FICA, and unemployment taxes comprise the company’s payroll tax liability, which it deposits with the IRS.
Capital gains tax liability
Capital gains tax liabilities apply to the sale of an asset or investment. They are the taxes you pay on the gain of the sale. So, for example, if someone buys an asset for $80,000 but sells it for $100,000, the difference of $20,000 is taxable as a capital gains tax liability.
Sales tax liability
The government imposes a sales tax on companies for each good or service it sells, with a few exemptions. After collecting these taxes, the company has a sales tax liability. Therefore, it’s a requirement for these companies to submit these tax liabilities to local or state governments.
Self-employment tax liability
Self-employment tax liability is the Social Security and Medicare tax that applies to self-employed individuals. Usually, they calculate these taxes themselves using Form 1040 or 1040-SR. The self-employment tax rate is 15.3%, where 12.4% goes to Social Security and 2.9% to Medicare. Small business owners have self-employment tax liabilities unless the business is incorporated.