As a small business owner, you have to juggle many different expenses. One expense you’re responsible for is your company’s taxes. The government enforces taxation on several aspects of your business. What is tax liability?
What is tax liability?
Tax liability is the amount of money you owe to tax authorities. Tax authorities include your local, state, and federal governments. The government uses tax payments to fund social programs and administrative roles. Tax liability is a legally binding debt, meaning you must pay the taxes you owe or you could face government penalties.
Tax liabilities are short-term liabilities. A short-term liability is a debt you incur from normal business operations. You pay short-term liabilities within a year. You report tax liabilities with other short-term debts on your balance sheet.
A taxable event is a transaction that has a tax consequence. The government decides which events are taxable. Each time a taxable event occurs at your business, you need to pay the appropriate tax authority.
Taxable events include earning taxable income, making sales, and issuing payroll.
Depending on the taxable event, you will owe a different amount of tax liability. You calculate tax liability as a percentage of the total taxable event.
Sales tax liabilities
When you sell a product, the government may charge you sales tax. You don’t pay sales tax directly out of your pocket. Instead, you include the sales tax in the total amount you charge customers.
Once you collect sales tax, you need to send and report it to local and state government agencies. You remit sales tax on a regular basis, such as monthly or quarterly.
For example, Nick’s Jewelry Shop sells necklaces. The business charges 6% state sales tax on its products. A necklace sells for $50.
The necklace generates $3 in sales tax:
$50 X 6% = $3 Sales Tax Liability
The jewelry shop needs to pay money collected from every sale to the state by the required due date.
Earned income tax liabilities
Earning income is also a taxable event. Usually, state and federal income tax payments are due based on a percentage of your earned income.
Depending on your business structure, your income might be double taxed. Double taxation occurs when you and your business are considered two separate entities. Corporations are separate entities from their owners. If you own a corporation, your business’s income is taxed. Then your personal income is also taxed.
On the other hand, sole proprietorships, partnerships, and LLCs are not double taxed. The income is only taxed once because the owner and business are considered the same tax entity.
Payroll tax liabilities
Your employees’ wages are subject to payroll taxes. You need to withhold certain taxes from their income and match other taxes.
You withhold your employees’ income taxes and the employee shares of Social Security and Medicare taxes. You also need to pay the employer’s share of Social Security and Medicare taxes. You calculate payroll taxes as a percentage of each employee’s wages.
Why tax liability matters to you
You need to understand your tax liabilities and when you must pay taxes. If you do not pay the correct amount of tax liabilities on time, you might face government penalties. Some penalties include a fine, tax lien, or even jail time.
To avoid government penalties, stay up-to-date on tax laws, collect and set aside the correct amount of taxes, and pay taxes on time.
To manage your tax liabilities, it’s essential to have organized accounting records. Patriot’s small business accounting software is easy to use and keeps all your records in order. Try it for free today.