A guide to effectively manage your tax liabilities
Managing taxes can be challenging for an individual or business venture, as it requires careful calculations and a clear understanding of income, expenses, and transactions.
Still, tax compliance is vital for all businesses. This is not just to avoid penalties, but also to support long-term business growth and financial stability. A proactive approach to managing financial obligations directly correlates with enhanced financial flexibility.
In this article, we’ll walk you through the basics of tax liabilities, why they matter, and practical strategies to manage them more effectively.
What are tax liabilities?
Tax liability pertains to the total amount of tax legally owed by a business or an individual to the government, like the Internal Revenue Service (IRS).
These obligations are acquired from various taxable financial activities, which include income earning, generating profit, or movements relative to sales and income generation, and are subject to applicable tax law.
Successful tax liability management means understanding your obligations and implementing proactive measures for timely compliance and optimized financial outcomes.
How tax liabilities are calculated
Your gross tax liability serves as the initial step in calculating your overall tax liabilities. To properly calculate this, your total tax deductions shall be subtracted from your taxable income.
Meanwhile, gross tax liability minus all applicable tax credits and deductions will determine your total income tax liability.
Tax specialists typically perform tax computations using the following guide:
Identify your entity type
How your taxes are calculated depends on the type of business you operate.
- C corporations pay corporate income tax directly. The company itself is taxed on its profits, separate from the owners.
- Pass-through entities like sole proprietorships, partnerships, S corporations, and most LLCs don’t pay corporate tax at the business level. Instead, profits and losses “pass through” to the owners, who report them on their personal tax returns and pay at their individual tax rates.
Knowing your entity type is important because it determines whether taxes are handled at the corporate level or passed on to you as an owner.
Calculate taxes for C corporations
Under the updated Tax Cuts and Jobs Act, C corporations are taxed at a flat 21% corporate income tax rate. This means the business pays 21% on its taxable income, no matter how much profit it generates.
Before the tax reforms of 2018, the previous corporate tax rate was 35%.
Calculate taxes for other types of entities
If you are not a C corporation, your business profits generally “pass through” to your personal tax return, and you’ll pay taxes based on individual income tax brackets rather than the business itself paying the tax.
Your tax rate depends on both your total taxable income and your filing status (single, married filing jointly, married filing separately, or head of household).
The IRS uses a progressive tax system, which means your income is taxed in layers — not all at the same rate.
| Tax Rate | Single Filers | Married (Joint Filing) | Married (Separate Filing) | Head of Household |
| 10% | Up to $11,600 | Up to $16,550 | Up to $23,200 | Up to $11,600 |
| 12% | $11,601 – $47,150 | $16,551 – $63,100 | $23,201 – $94,300 | $11,601 – $47,150 |
| 22% | $47,151 – $100,525 | $63,101 – $100,500 | $94,301 – $201,050 | $47,151 – $100,525 |
| 24% | $100,526 – $191,950 | $100,501 – $191,950 | $201,051 – $383,900 | $100,526 – $191,150 |
| 32% | $191,951 – $243,725 | $191,951 – $243,700 | $383,901 – $487,450 | $191,151 – $243,725 |
| 35% | $243,726 – $609,350 | $243,701 – $609,350 | $487,451 – $731,200 | $243,726 – $365,600 |
| 37% | $609,351 and up | $609,351 and up | $731,201 and up | $365,601 and up |
If your total taxable income is $12,000 or greater, your income will typically be taxed within multiple brackets.
To cite an example, if a single filer, Ciarra, has a total taxable income of $25,000.00, she will fall under two levels of brackets and will be taxed using two different rates:
First bracket ($0 to $11,600) = 10%
Second bracket ($11,601 – $47,150)= 12%
She will pay two different tax rates, which are the 10% on the first $11,600 “chunk” of her income, and another 12% of the remaining amount.
Translating this to the equation will give us the following computation:
Total tax = (10% x $11,600) + (12% x [$25,000-$11,600])
Total tax = $1,160 + $1,608
Total tax amount = $2,768
In this example, Ciarra’s marginal tax rate in this case is 12%, which represents the highest tax bracket she reached.
Reducing tax liabilities using deductions and credits
Did you know that you can reduce tax liabilities through deductions and tax credits? While both can save you money, they work in different ways.
Tax deductions lower your taxable income. This means the IRS taxes you on a smaller portion of your earnings, and your savings depend on your tax bracket.
For example, if Caleb, who is in the 22% tax bracket, claims a $1,000 deduction, he saves $220 in taxes.
On the other hand, tax credits directly reduce the amount of tax you owe. If Caleb qualifies for a $1,000 tax credit, this exact amount will be reduced from his tax bill, regardless of his tax bracket.
By strategically using the right mix of credits and deductions, businesses and individual taxpayers can minimize their tax liabilities and keep more of their earnings.
Common types of tax liabilities
Tax liabilities comprise all financial obligations that a business or individual legally owes to the government. These arise from multiple economic activities, which include:
- Income taxes: The most common type of tax levied on both individuals and corporations. Income taxes are based on earnings, such as:
- Salaries and wages
- Professional fees
- Investment income
- Business profits
- Consumption taxes: Taxes that are levied on the purchase of goods and services, such as:
- Value Added Tax (VAT)/Sales tax
- Excise tax
- Property taxes: Taxes that are computed based on the assessed value of real estate and, in some cases, personal property collected by the local government.
- Employment or payroll taxes: Taxes incurred to fund an employee’s social security, health care, and unemployment benefits. Self-employed individuals pay similar obligations through the self-employment tax.
- Capital gains taxes: Taxes that are rated based on the sale of assets like real estate, stocks, bonds, and other appreciating investments.
- Transfer taxes: Imposed when property changes hands, including estate taxes (on inheritance) and gift taxes (on property given without compensation).
3 Ways to effectively estimate your tax liabilities
Estimating your tax liabilities allows you to plan for your finances ahead of time and avoid possible risks of penalties and late payments.
Here are some of the ways that can guide you in estimating tax liabilities:
1. Review previous tax returns and project changes
Reviewing previous years’ documents and receipts is a great practice to help with your tax estimates. Project possible changes based on the IRS forms you filed, income sources, credits, and deductions from last year.
Compare it with your current earnings and factor in any possible adjustments, such as a salary increase, new investments, or a change in filing status. This gives you a realistic baseline for your estimates.
2. Keep detailed records of income and expenses
Accurate recordkeeping is key to making reliable tax estimates. Track receipts, invoices, and other financial documents throughout the year.
The more precise your records, the easier it will be to update figures and project your tax obligations correctly.
3. Use online withholding and tax calculators
Government agencies, including the IRS, provide free online tax estimators. By entering your income, deductions, and filing status, you can instantly generate a tax estimate. These tools make it simple to adjust numbers as your situation changes.
The lasting value of proactively managing your tax liabilities
Ultimately, managing tax liabilities with a proactive approach not only focuses on simply filing taxes on time, but it is a great way to build long-term financial health.
By learning the basics of tax laws, including the accurate estimation of your obligations and maximizing available credits and deductions, you can minimize penalties and keep more of your earnings.
Taking a forward-looking approach empowers you to optimize resources, maintain financial stability, and align your money with both personal and business goals.
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