Nothing is certain in business—except for a yearly tax bill.
If you live in the United States, you can expect your federal tax liability to reflect a combination of revenue, expenses, and applicable tax rates, and predicting the details can be challenging. Different types of income, deductions, and tax credits all play a role in determining how much a business owes. Paying taxes is non-negotiable, but you can minimize your liability—if you’re strategic.
Effective tax planning involves more than sending your tax return to the Internal Revenue Service (IRS) at the end of the year. It’s about structuring business decisions (e.g., deferring revenue or taking advantage of tax credits) to strategically lower what you owe.
In this guide, we’ll explore the ins and outs of tax liability, how to predict your annual tax bill, and ways to lower it.
What is tax liability?
Simply put, tax liability refers to the amount of tax owed by an individual, business, or other entity. In the U.S., this money goes to the Internal Revenue Service (IRS). One’s tax burden might include income tax, self-employment tax, or other taxes based on earnings.
Business owners and self-employed individuals don’t pay taxes all at once. Instead, tax deadlines are spread out quarterly. Since taxes aren’t automatically withheld like they are for W-2 employees, it’s wise to budget for these payments to avoid penalties.
Tax liability is calculated based on your tax bracket, which is determined by how much you earn or the structure of your business. For example, a sole proprietor pays taxes on business profits through their personal tax return, meaning income is taxed at their individual tax rate. Conversely, a corporation is considered a separate tax entity and is taxed at a corporate rate, separate from its owners.
For some, tax payments are relatively straightforward. Others must account for additional taxes, special credits, or deductions. Proper planning ensures you meet your obligations without costly surprises.
How to calculate tax liability
In the U.S., calculating your federal tax liability begins with determining your taxable income, which is your total earned income minus any deductions or exemptions. The IRS employs a progressive tax system—the higher your income, the higher the percentage owed.
Tax brackets
The IRS sets specific tax brackets each year, defining the income range taxed at each rate. For example, here are the federal income tax brackets for a single filer in 2024:
- 10% for incomes at or below $11,600 ($23,200 for married couples filing jointly)
- 12% for incomes over $11,600 ($23,200 for married couples filing jointly)
- 22% for incomes over $47,150 ($94,300 for married couples filing jointly)
- 24% for incomes over $100,525 ($201,050 for married couples filing jointly)
- 32% for incomes over $191,950 ($383,900 for married couples filing jointly)
- 35% for incomes over $243,725 ($487,450 for married couples filing jointly)
Note that your entire income isn’t taxed at the same rate. Under a progressive tax rate, only the income within a specific range is taxed at a higher rate. If you earn $50,000, the first $11,600 is taxed at 10%, the next $35,550 is taxed at 12%, and the final $2,850 is taxed at 22%. Therefore, your take-home pay will never decrease simply because of a raise that puts you in a higher tax bracket.
Standard deduction
A standard deduction is a fixed amount you can subtract from your total income to reduce your tax liability. It’s available to most taxpayers and helps lower the amount of income subject to tax without requiring you to itemize specific deductions. Deduction amounts vary depending on whether you’re a single filer, married filing jointly, or head of household.
Deductions and credits
Beyond your standard deduction, you can apply for other credits. Child tax credits, education credits, and retirement contributions can all minimize your liability.
Taxable income
After applying your standard deduction (or itemizing deductions), you are left with your taxable income. You can then determine your final income tax liability by applying the appropriate tax rates.
Tax liability considerations according to your business type
A small business must be classified as a specific entity type for tax purposes. It may be a C corp, LLC, sole proprietorship, or other entity. But when figuring out your tax burden to the IRS, it’s simple: C corps pay taxes independently, and everyone else is in the “flow-through” category.
C corporations vs. flow-through entities
The primary difference between a C corporation and other business entities is that C corporations are taxed at the corporate level. The business itself pays taxes on its revenue before dividends are paid out to shareholders.
The downside? Double taxation—profits are taxed at the corporate level and again when they are distributed to owners.
If you’re not a C corp, you pay taxes as a flow-through entity. The organization doesn’t pay taxes. Instead, profits (and losses) “flow through” to the owners or shareholders, who report them on their tax returns as a sole proprietor, partnership, LLC, or S corp. Profits are taxed at the owners’ individual rates based on their personal tax brackets.
If you don’t formally set up your business entity, the IRS will classify you as a sole proprietor by default. You must report your business income on your personal tax return. This classification affects other areas of your business, like liability protection and how business debts are handled. Consider consulting with an accountant to determine the best business entity classification for your enterprise.
How to reduce tax liability
No matter how lean your finances are, there are probably ways to reduce your small business’s tax liability. Here are four potential strategies to lower your tax bill:
1. Take advantage of tax deductions
Internet providers, business lunches, fancy pens—you can deduct those. Keep detailed records of every expense related to your business. Consider using a separate debit or credit account for your business expenses, especially if you’re an independent contractor or remote worker with home office expenses. This will help you itemize your expenses when filing.
2. Contribute to retirement plans
Contributing to a 401(k) or traditional IRA can reduce your taxable income and prepare you for your financial future. Contributions to specific retirement plans are tax-deductible, reducing the amount of income you pay taxes on. However, Roth IRAs are funded with post-tax dollars and don’t reduce your taxable income.
3. Apply for tax credits
Tax credits reduce your actual tax bill. Businesses can take advantage of several types of tax credits, such as by creating an employer pension plan or making energy-efficient business improvements.
4. Adjust payroll exemptions
When you file a W-4 form with your employer, you can adjust your payroll withholdings based on your expected income. The number of exemptions or allowances you claim determines how much tax is withheld from your paycheck.
Accurately adjust your withholding amounts to avoid overpaying taxes throughout the year, freeing up more of your money. But be cautious. If you underpay payroll taxes, you’ll owe taxes at the end of the year.
Business tax compliance is easier with Oyster
Navigating tax compliance can be challenging, whether you manage remote workers across different states or lead an internationally distributed team. Oyster simplifies the process with built-in tax features, global payroll management, EOR services, and in-house legal expertise. The Oyster platform is built for global compliance to ensure that you align with federal and global tax laws so you can focus on growing your business with confidence.
FAQs
Are tax liability issues still not adding up? Here are a few common questions:
How does tax liability work for capital gains?
Capital gains are profits one earns from selling assets like real estate, stock, or bonds. The tax is calculated on the difference between the selling price and the asset’s purchase price. However, the actual capital gains tax rate depends on how long you hold the asset. Short-term capital gains (for assets held for one year or less) are taxed at ordinary income tax rates, whereas long-term capital gains (assets held longer than one year) are taxed at reduced rates, depending on your income level.
What’s the difference between a liability and a refund?
Tax liability refers to the amount of tax you owe to the IRS. A tax refund occurs when you overpaid your taxes throughout the year—either through excessive withholding or overestimated tax payments. If your payments exceed your liability, the IRS will issue a refund.
Can small businesses reduce tax liability with expenses?
Yes, businesses can expense costs to lower their tax liability. The IRS requires a deductible expense to be ordinary (common in your industry) and necessary (essential for business operations). Examples of tax liability deductions include advertising expenses, office supplies, and wages for independent contractors.
About Oyster
Oyster is a global employment platform designed to enable visionary HR leaders to find, engage, pay, manage, develop, and take care of a thriving distributed workforce. Oyster lets growing companies give valued international team members the experience they deserve, without the usual headaches and expense.
Oyster enables hiring anywhere in the world—with reliable, compliant payroll, and great local benefits and perks.
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