In 2021, the U.S. government collected an estimated $4.05 trillion in tax revenue. A significant portion of that crazy-high figure consists of federal income tax liabilities. But what exactly does that mean, and how does it affect your finances?
Federal income tax liability refers to how much you owe the federal government based on the income you earn annually. The more you earn, the more you pay. If your income is lower than the standard deduction, you won't owe any tax at all. Either way, it's crucial to understand how income tax works.
Frankly, you're not alone if you think taxes are super confusing. The good news is that we're here to help ease the burden of figuring things out on your own. In this post, we define what federal income tax is, explain how to calculate it, and provide some examples so that calculating what you owe is a far less frustrating process.
What Is Federal Income Tax Liability?
Let's be honest: taxes are the bane of every working person's existence. Pay too much, and you're giving the government an interest-free loan. Pay too little, and you may face a tear-inducing bill come tax time. Don't pay at all, and you could find yourself arrested for tax evasion.
You don't want any of these scenarios, so let's begin with the basics.
Federal income tax is a tax imposed by the United States federal government on an individual's income. It's calculated by applying a tax rate to taxable income, which refers to your total income less allowable deductions. Since the U.S. has a progressive tax system, individuals with high incomes pay more tax than individuals with low incomes.
But let's dig into this further so that you fully understand your total tax liability.
Total Tax Liability Meaning
You accrue tax liabilities through taxable events, such as earning a wage or salary. Your total tax liability is the amount you owe in a given period.
If you're employed, your employer will withhold portions of your earnings to cover your liability. If those withholdings are less than your total liability for the year in question, you'll need to pay the difference. If withholdings exceed your total liability, you'll get the difference back in a tax refund.
If you're self-employed, there are no withholdings to offset your liability, so you'll need to pay the full amount out of pocket.
Fortunately, all taxpayers can lower their tax liability by claiming allowable deductions, exemptions, and tax credits. What's the difference between them?
A tax deduction is any portion of taxable income you're allowed to exclude from taxation if it satisfies certain conditions, while a tax exemption constitutes certain earnings that weren't subject to taxation in the first place.
A tax credit refers to an incentive offered by the government that lets you subtract a specified amount from your federal tax liability. It's the government's way of rewarding the support of public goods or desired behavior, such as paying for childcare, supporting an elderly parent, or buying your first home.
How Is Tax Liability Calculated?
Calculating tax liability is where most people get confused, so let's walk through it step by step.
Step 1: Determine your gross taxable income for the applicable year.
The first thing to do is figure out your gross taxable income for the relevant tax year. This amount may include wages, a salary, commissions, income from any side business activities, tips, bonuses, alimony payments, unemployment payments, retirement fund distributions, interest income, capital gains income, and any state and local tax refunds.
Some types of income are exempt from taxation, including child support payments, welfare payments, inheritances, life insurance policy pay-outs, gifts, federal tax refunds, and tax-exempt bond interest.
Once you've added up your gross taxable income, it's time to move to the next step.
Step 2: Calculate your adjusted gross income.
Your adjusted gross income (AGI) is your gross taxable income minus above-the-line tax deductions and other adjustments. This includes health insurance premiums, your retirement plan contributions, student loan interest, and any alimony you've paid.
The AGI figure you arrive at is your actual income—the amount that serves as the basis for your taxes.
Step 3: Subtract your tax deductions.
When it comes to tax deductions, you will typically have two options: 1) a standard deduction or 2) itemized deductions. Since deductions reduce your taxable income, you'll want to use the method that results in the highest amount being subtracted.
With that in mind, let's take a look at each option.
Option 1: Standard Deduction
A standard deduction is a set amount the Internal Revenue Service (IRS) allows you to deduct from your AGI as non-taxable. Each year, the amount changes to account for things like inflation.
The following table outlines the standard deductions for each filing status for the 2022 tax year.
Standard Deduction Amount
(2022 Tax Year)
|Head of household||$19,400|
|Married (filing jointly)||$25,900|
|Qualifying widow or widower||$25,900|
|Married (filing separately)||$12,950|
For example, let's say your AGI is $100,000 and that you're filing as a single individual. Your calculation would look like this:
$100,000 – $12,950 = $87,050
You'll then apply the relevant tax rates to the $87,050 figure. (There's more on how this is done in our examples section below.)
Option 2: Itemized Deductions
Itemized deductions are qualifying expenses the IRS lets you claim on your tax return to reduce your AGI. You can check out the full list of itemized deductions on the IRS's website. They include things like charitable contributions, the use of your home or car for business purposes, business travel expenses, work-related educational expenses, mortgage interest, and more.
If the sum of these expenses is more than the standard deduction, you'll want to choose this method of reducing your tax liability. However, if the opposite is true, you'll want to take a standard deduction.
Step 4: Work out your total federal income tax owed.
Last but not least, you need to calculate how much you owe the IRS based on the tax brackets that apply to your taxable income.
There are seven tax brackets in total, but they're not as intuitive as they appear. That's because most taxpayers have to look at several tax brackets to work out what they owe. What do we mean by that?
Well, let's first look at the tax rate for each tax bracket in 2022.
|2022 Tax Brackets|
|Tax Rate||Single||Married (Filing Separately)||Married (Filing Jointly) / Qualifying Widow or Widower||Head of Household|
|10%||$0 – $10,275||$0 – $10,275||$0- $20,550||$0 – $14,650|
|12%||$10,276 – $41,775||$10,276 – $41,775||$20,551 – $83,550||$14,651 – $55,900|
|22%||$41,776 – $89,075||$41,776 – $89,075||$83,551 – $178,150||$55,901 – $89,050|
|24%||$89,076 – $170,050||$89,076 – $170,050||$178,151 – $340,100||$89,051 – $170,050|
|32%||$170,051 – $215,950||$170,051 – $215,950||$340,101 – $431,900||$170,051 – $215,950|
|35%||$215,951 – $539,900||$215,951 – $323,925||$431,901 – $647,850||$215,951 – $539,900|
Now, most people would instinctively review the tax brackets, assess where their taxable income falls, and apply the tax rate based on how they plan to file (e.g., single, married, etc.).
But that's not quite how it works.
Instead, you need to apply the tax rate for each tax bracket as your income falls within a new level. In other words, falling within a certain tax bracket doesn't mean you'll pay that rate on all of your taxable income. You'll pay 10% on the first $10,275, 12% on the difference between $10,276 and $41,775, and so on.
The best way to show you how it works is with examples.
Tax Liabilities Examples
Peter's adjusted gross income is $65,000. He opts for a standard deduction and plans to file as a single individual.
Based on this information and the tables above, Peter's federal income tax liability calculations would work as follows:
$65,000 – $12,950 = $52,050
As you can see, Peter's income falls within the third tax bracket, but he isn't going to be paying 22% on all of his income. Rather, he would follow the tax rate up the scale, levying tax on each new tax bracket he hits accordingly.
|Tax Rate||Single||Calculation||How Much Pete Owes|
|10%||$0 – $10,275||$10,275 x 10%||$1027.50|
|12%||$10,276 – $41,775||($41,775 – $10,276) x 12%||$3779.88|
|22%||$41,776 – $89,075||($52,050 – $41,776) x 22%||$2260.50|
$1027.50 + $3779.88 + 2260.50 = $7067.88 (Peter's total federal income tax liability)
What overall percentage of tax does Peter actually have to pay? Just 13.5%, which is far lower than the 22% tax bracket within which his income falls. This is known as the effective tax rate, which is calculated by taking the total tax owed and dividing it by the total taxable income.
John and Sarah are a married couple who have a combined adjusted income of $320,000. Their itemized deductions total $27,300, which is more than what the standard deduction allows for spouses filing jointly.
They would calculate their federal income tax liability as follows:
$320,000 – $27,300 = $292,700
|Tax Rate||Married (Filing Jointly)||Calculation||How Much John and Sarah Owe|
|10%||$0- $20,550||$20,550 x 10%||$2055.00|
|12%||$20,551 – $83,550||($83,550 – $20,551) x 12%||$7559.88|
|22%||$83,551 – $178,150||($178,150 – $83,551) x 22%||$20,811.78|
|24%||$178,151 – $340,100||(292,700 – $178,151) x 24%||$27,491.76|
$2055.00 + $7559.88 + $20,811.78 + $27,491.76 = $57,918.42 (John and Sarah's total federal income tax liability)
What's their effective tax rate? It's 19.7%—again, much lower than the 24% tax bracket within which their income falls.
A Final Word on Tax Liabilities
Figuring out what you owe can be confusing, but you need to do it if you want to avoid problems with the IRS. When in doubt, hire a tax consultant or an accountant with experience to help you unravel the mysteries of the United States tax system. Whatever you do, make sure you pay what you owe.
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Shawn Manaher is a former financial advisor, has founded 5 online businesses, and is a coach, speaker, podcast host, and author. He's been featured on Forbes, The Consults Corner on TAE Radio, The Writing Biz, What's Your Story, and more.